CentreRight

A tax cap: an idea whose time has come?

By Alex Estorick, Intern, Reform.

As Tim Montgomerie noted earlier today, Britain needs an agenda for keeping talented people in Britain and moving to a low tax economy should be a key part of this.

In October this year Kinetic Partners estimated that around 1,000 hedge fund managers (with an average income at £1.5 million to £2 million per year) have left the UK. They estimated that the loss to the exchequer has already reached a minimum of £500 million. City AM also recently highlighted that if bankers’ bonuses were reduced from £7 billion to £4 billion, as has been mooted, HMRC would lose £1.8 billion in revenue. One factor in these changes has been a desire to make the taxation of higher earners fairer. But should we be concerned if rich people are leaving the UK?

It is not surprising that people debate the taxation of high income earners. In an environment when many families are facing increasing costs of food, lower benefit payments and the prospect of a post-Christmas increase in VAT, attention naturally turns to ensuring that people who have incomes many, many times the pay of the average family pay their “fair share.”

Yet to have an honest debate on whether the tax system is actually fair it is necessary to first debunk certain misconceptions about taxes on higher earners. High income earners make a large contribution to tax revenue in the UK. The richest 1 per cent of taxpayers provide nearly a quarter of total income tax revenues and the richest 10 per cent provide over half. The UK relies on this group to fund a large proportion of public services.

There is concern that recent changes such as the 50p tax rate, claw-back of personal allowances and reduction in relief for pension contributions have led to the perception of the UK being a hostile (and uncompetitive) tax environment. The 50p tax rate on incomes over £150,000, for example, means the UK has the joint fourth highest top rate in the EU.

The loss of tax revenue when high earners leave the country (or decide not to come here in the first place) means that spending cuts have to be higher than otherwise, or additional tax rises are needed. So the question then becomes how do we balance fairness (such as a desire to alleviate poverty) with a desire to ensure that the tax system does not encourage the most mobile and productive workers to leave the country. One idea that has been considered in countries like New Zealand is that of a tax cap.

In 2001 a Ministerial Inquiry into the Tax System (the McLeod Review) established by a Labour Government considered the idea of a tax cap. This tax cap would limit the amount of tax that any individual would pay. The aim of the cap was to both attract high-income non-residents who may be tempted to locate to New Zealand and retain wealthy (internationally mobile) residents.

The key limitation to the tax cap (aside from the foregone revenue, which may be moderate if the gains from retaining higher earners in the tax base are considered) is the perception of fairness. How fair is it to cap the taxes of the highest income earners when so many other families are facing difficult times? The answer is, as optimal tax theory has shown, lower tax rates at the very top of the income distribution can potentially lead to higher income earners paying more, not less, tax. Given this, perhaps this is exactly the sort of approach that a fair tax system should take?

The Spending Challenge: A wasted opportunity for an honest debate

By Anna Williams of Reform.

In June, when the Government set out how it was going to conduct the Spending Review there were high hopes for a highly engaging and constructive process - a process that would really captivate the public and involve it in public sector reform.

The Treasury’s Spending Challenge set out to create the most collaborative Spending Review ever, with over 100,000 ideas submitted from the public and a further 63,000 from the public sector. From this, however, only 25 ideas were taken forward as Government policy. This consultation should and could have gone further.  Rather than just being a process of generating individual ideas for efficiency, it should have begun an honest debate on the magnitude and general nature of the budget actions that the country needs. After all whilst cutting the deficit is a priority, even before the economic crisis there was a need for a high level of structural reform.

A contrast can be made with Canada in the 1990s. In 1993 they had one of the highest debt levels bar Italy of the developed world, but by 1998 the deficit had been eliminated and the debt ratio was dropping. Central to this success was the Canadian Governments’ approach to engaging the Canadian public in the development of their fiscal plans.

This included a consultation process that began more than four months before Budget day and included the release of major background papers and public hearings by the Parliament’s Finance Committee. This stimulated an outpouring of detailed mock budgets by various interest groups, media columnists and individual citizens. The then Finance Minister, Paul Martin, has argued that this consultation contributed importantly to creating reasonable expectations about the cuts and reforms that were going to take place as well as helping ensure that no stone was left unturned in re-examining the Government’s role.

The approach in the UK has, in contrast, left local people not fully aware of the difficult decisions that lie ahead. This can be shown in the response to a public consultation that Reform held in Cannock Chase. As Julian Glover blogged for the Guardian “there was an anaesthetised acceptance of impending pain.” Surprisingly, this event was also the first time that many of the local leaders had met each other. The value of the event was that it opened up lines of communication and moved the debate from one of cuts to one of meaningful reform. A dialogue like this, between different areas of the public sector, constructively allows areas of overlap to be recognised, and solutions to be created that are shared rather than isolated.   

The government has made it harder for itself to take part in a real re-examination of the role of government in society by not engaging effectively in an honest public debate. Experiences from Canada and Reform’s own work in the run up to the Spending Review have shown that sparking debate, igniting innovation and public understanding could have added real value to reforms now taking place. The Spending Challenge as much embodied an opportunity as did a threat. Unfortunately this opportunity was wasted.

Patrick Nolan: Anti-business policies delay recovery

Dr Patrick Nolan, Chief Economist, Reform

Tomorrow is 81 years since “Black Tuesday,” 29 October 1929, the day when prices on the US stock market collapsed and a range of events were set in motion that led to the Great Depression. This Depression devastated the world economy and some countries did not recover until the late 1930s or early 1940s.

The Great Depression provides lessons for the economic challenges we face today. Yet these differ from those we often hear. In particular, rather than purely being a failure in markets, recent scholarship has shown how policies that reduced competition and labour market flexibility made the Depression longer and more severe. This highlights the real danger of policy that damages the business environment and why, as Rt Hon David Cameron noted this week, encouraging private sector growth must be central to the Coalition’s economic policy.

To explain how government policy extended the Depression it is necessary to look at the detailed policy response in the US. The major policy response, the New Deal, created the system of Social Security in the US, contained steps to build confidence in the banking industry, strengthen banking regulation and curtailed speculation (the Glass-Stegall Act), and strengthen depositor and investor confidence (creating the Federal Deposit Insurance Corporation and the Securities and Exchange Commission).

However, the New Deal also included a National Industrial Recovery Act, which weakened competition laws and allowed industries to collusively increase prices. Although this Act was struck down as being unconstitutional in 1935, the policies of collusion it introduced continued. As Cole and Ohanian noted:

“There was no antitrust activity after the NIRA, despite overwhelming FTC evidence of price-fixing and production limits in many industries, and the National Labor Relations Act of 1935 gave unions substantial collective-bargaining power. While not permitted under federal law, the sit-down strike, in which workers were occupied factories and shut down production, was tolerated by governors in a number of states and was used with great success against major employers, including General Motors in 1937.”

The result was, as Cole and Ohanian go on to argue:

“a deepening of New Deal polices that raised wages even further above their competitive levels, and which further prevented the normal forces of supply and demand from restoring full employment. Our research indicates that New Deal labor and industrial policies prolonged the Depression by seven years.”

This can help explain why, as Milton Friedman has observed, “this was the only occasion in our record when one deep depression followed immediately on the heels of another.”

These findings are, not surprisingly, controversial. A range of other explanations have been given for the severity of the Depression, including the effect of government action following 1929 (or earlier inaction during the 1920s) on the money supply and the reduction in international trade and rise in tariffs following the Smoot-Hawley Act.

Yet what Cole and Ohanian highlight is the importance of the business environment and how a poor business environment can make the chance of a double dip more, not less, likely. To avoid the policy mistakes of the Great Depression we need supply side reforms that encourage competition and flexible labour markets. As Reform argued in our alternative Budget, “This requires broad-based and low rate taxation, deregulation and a flexible labour market. Targeted support for business should be time limited and focused on where the economic case is strongest.”

How to scale back welfare spending - and close the deficit

By Thomas Cawston

Welfare is the biggest budget and the Coalition has rightly put it at the heart of the Spending Review. At £194 billion the welfare bill is almost twice as much as the cost of the NHS. As Tim blogged earlier today, new research by Reform documents the growth in this expenditure over the last decade and how to scale it back to the close the deficit. There are two ways to reduce welfare expenditure. The first is to reduce the costs of unemployment and social failure and the second is to cut the bulk of welfare spending that is directed at the middle classes. The Government’s welfare reform has focused on the former and proposed a series of policies to end welfare dependency.
 
Key to this agenda is Iain Duncan Smith’s plan for a complete reform of the benefit system to tackle disincentives to work. While the current benefit system is complex and creates poor incentives, Government reforms would combine existing benefits into a new single benefit. This would allow individuals to keep some of the income from out-of-work benefits when they enter employment, removing poverty traps and creating financial incentives to work. This would ensure that “work always pays”. But the plan to increase this “earnings disregard” is not a silver bullet, the proposals comes with significant trade-offs and leaves unanswered questions.
 
    ▪    How important are financial incentives?  It has been assumed that people will respond to financial incentives to enter employment, but international evidence highlights that they are not everything. Also important are factors such as age, availability of childcare and other barriers to employment such as a history of worklessness.
    ▪    What kind of work pays? Creating an “earnings disregard” for the entry into work effectively means an incentive for low wage, low status and part-time employment. There is subsequently little or no incentive for individuals to increase their incomes or for second earners to enter the labour market, while more people will stay on in-work benefits.
    ▪    The costs of making it work? The universal credit comes with upfront costs that have been put at £2.7 billion. In addition, creating a benefit system that responds to constant changes in household income and need requires more administration and a sophisticated IT system. With the UK ’s poor record of national IT programmes and much cited examples of computer errors in calculating personal taxes, the universal credit is potentially unworkable.  
    ▪    Creating incentives for the wrong people? The Government’s welfare reforms are focused on young people and the long-term unemployed. However fiscal consolidation will lead to growing unemployment among the public sector workforce, which is comprised of older workers and a higher proportion of women. This requires a different set of measures to support people back into work.
 
The Work Programme is a better idea and the Government hopes to have the programme up and running by next year. But international experience suggests that creating a competitive market for welfare-to-work financed by payment by results takes years to develop, requiring constant policy adjustment to align incentives for providers to deliver the best services. Also financing welfare-to-work services with savings to be made in the future creates a higher degree of risk for providers. This needs to look like an investment, not a gamble, and there is still significant uncertainty over how much it costs to help a long-term Incapacity Benefit claimant into work. Rather than rushing out the programme for next year a gradual introduction would offer a better opportunity to ensure the optimal alignment of incentives, the best way to manage financial risk and an effective market framework that supports competition.
 
Moving people out of benefits and into work takes time and is not easy. There is no simple solution to such a complex problem. Moreover, the Government’s flagship welfare reforms fail to address the true costs of the welfare state. Out of work benefits, such as the Jobseeker’s Allowance, Incapacity Benefit, Employment Support Allowance and Income Support, account for 10 per cent of welfare expenditure. High welfare spending today reflects middle class welfare and not the costs of unemployment. Ending this money-go-round, a system of universal benefits and higher taxes, is the real welfare reform agenda needed for this Parliament.

Thomas Cawston is a researcher at Reform

Reform’s latest report The money-go-round is available at www.reform.co.uk

From Central Doom to Local Hope?

By Professor Nick Bosanquet, Professor of Health Policy, Imperial College, and Consultant Director, Reform

Is there any way in which the Coalition can avoid the nerve twisting rows that have already begun over school building, children’s playgrounds and free school milk?

The changes are portrayed as once for all cuts—but this is a media stereotype. Apart from the rare cases in which programmes are being eliminated entirely, what is being recommended is a change in flow of funds over time. The size of the continuing flow should be highlighted and it should be judged against the level of funding that was happening before the pre-election period. In many case the “cut” programme will be still be receiving a level of spending greater than it was three or four years ago.

The new flow of funds should set a new direction in terms of localism. The Coalition should not plan a once for all series of cuts—it should seek to bring about a radical shift in power and responsibility away from Whitehall. Local communities should be given responsibility for getting value from the new flow of funds. They have the incentive to search for innovative and lower cost ways of delivering services. Whitehall deals in spending not in value—and the challenge of reform requires a greater focus on value.

Each of the nerve twisters points to how this could be done. In the case of school buildings the Whitehall approach encouraged a fattening up of projects which were seen as a once for all chance. There was also little sense of responsibility for management of contracts, with a quango so inefficient that it did not even have an accurate list of current projects. Yet by presenting the changes in school building as ‘cuts at schools’ the Government has caused the maximum political pain.

Instead the Coalition could have allocated a reduced budget to local communities and then given them freedom to spend it. Changes need to be seen as introducing more flexibility in how funding is spent over time. Changes also need to be seen as part of a continuous process of improvement, as this would create greater incentives to get value.

In the case of playgrounds, after 13 years of inattention the previous government announced an unfunded programme for upgrading all the playgrounds in the country. Once again the Coalition’s response should have been to give a sustainable flow of funds to local communities. They may well have been able to find lower cost solutions and to organize partnership funding. The process should create hope for the future not a sense of community betrayal.

The free milk problem is at the crossroads of political symbolism and total anachronism. In 1946 the free milk programme had bi-partisan support. Indeed, in 1943 Churchill had said “There is no finer investment for any community than putting milk into babies.”

In 1946 providing free milk was a way of helping the increasing numbers of babies at a time of falling food availability. The diet doctrines at that time stressed the importance of fat content, particularly given the real risk of hypothermia in cold homes with coal and blankets in short supply. It was a time when the government had to decide what everybody was eating.

Now the problem facing our children is eating too much, not too little–and this problem starts young. The idea that government should decide that every child should have a carton of milk is a bizarre anachronism—especially when many children have too much fat already. An alternative approach could be to, for instance, halve the budget and give £25 million to local groups to organize refreshments for their own toddlers.

The emphasis should be on local choice. The Coalition should take the moral offensive on empowering local communities to deliver more value than Whitehall has. This would highlight that the proposed changes are a path towards a better and local future—not as a series of local dooms.

The NHS budget should not be sacrosanct

Dr Patrick Nolan is Chief Economist of Reform.

Tomorrow afternoon the coalition government will have the opportunity to change the direction of fiscal policy in the UK. As Reform noted in our alternative budget last week, while this will require making the toughest spending choices for a generation, history will judge the government right if they do this in the right way and reduce costs through structural reform.

International experience shows that the right way to cut spending is for this to occur over as broad a base as possible. No areas of spending should be off limits. Areas that account for the greatest shares of government spending, and in which spending performs most poorly, should bear the largest cuts. Signs are, however, that the health budget will be ringfenced from cuts, although this is the largest area of departmental spending, has poor rates of productivity and accounted for 40 per cent of the increase in public sector spending between 1997 and 2007.

Whether the NHS budget should be sacrosanct was a topic for debate on The Big Questions yesterday morning. On this show I argued that the NHS budget should be cut as this would not just save money but help encourage a better health system. I noted that “the NHS doesn’t need more money, it needs reform” and that the public needs to provide more funding for health out of their own pockets through user charges. Julia Manning of 2020 Health also opposed ringfencing the budget and argued that people need to take more responsibility for their own health.

If tomorrow’s Budget is to begin to start the process of rescuing the UK’s public finances it will need to take tough choices. Easy options, such as cutting consultancy budgets or gimmicks such as free swimming for pensioners, will only scratch the surface of what needs to be done. The risk is, however, that the Budget will fail to go beyond these easy options and public services like health will remain unreformed. Rather than rescuing the public finances this will simply be saving trouble for the future.

Eliminate the deficit in one Parliament

Dr Patrick Nolan is Chief Economist of Reform.

In six days George Osborne will release the coalition’s Emergency Budget. As an early contribution to the debate on this Budget, today Reform released its own Budget for the UK, Taking the tough choices. Two key questions that the Reform Budget raises for the coalition efforts are whether they will be ambitious enough in their timeframe for reducing the deficit and whether they can credibly claim to be restoring the public finances while refusing to cut the largest spending areas.

The coalition Budget will be likely to set out a plan to eliminate the bulk of the structural deficit in the term of this Parliament. Yet a target along these lines will not be ambitious enough. It will mean that the UK will only take half measures to face up to its deficit and problems with debt. The target should be to completely eliminate the deficit and return spending to 36 per cent of GDP within a term.

Moving slowly makes fiscal consolidation harder. The choice is some pain now or greater pain in the future. Unless reform to programmes and entitlements begin in next week’s Budget then the growing costs in areas like health and pensions will swamp any savings identified. The Office for Budget Responsibility has already noted that the cost of public sector pensions will increase by around £5 billion by the end of this Parliament, but even this will be dwarfed by the growing costs of pension and health entitlements more generally. The costs of benefits to pensioners alone will have grown by £12 billion by the end of this Parliament.

Countries that have successfully reformed their public finances moved quickly. In New Zealand in the 1990s the government went from a large deficit to running surpluses in 3 years and in Canada in the 1990s the process took 4 years. This meant that these governments stopped accumulating debt and were able to begin the task of repaying debt sooner. Indeed, as Rt Hon Paul Martin, former Canadian Finance Minister and Prime Minister, noted in a foreword that he wrote for the Reform budget: “because the cuts were sharp and deep they worked – the vicious circle turned virtuous and the positive payback was not long in coming.”

International experience also highlights that fiscal consolidation should occur over as broad a base as possible. No areas of spending should be off limits. Groups who argue for cuts in other areas while trying to protect their own patch fail to grasp the scale of the problem. The hole in the public finances is so deep that every cut in spending that can be made should be made. Further, areas that account for the greatest shares of government spending, and in which spending performs most poorly, should bear the largest cuts. This includes spending on health and middle class welfare, like the Winter Fuel Allowance and the Child Benefit.

As Hon Ruth Richardson, a former New Zealand Minister of Finance, who also contributed a foreword to the Reform Budget, said: “Imposing a lid on increases in public spending, eliminating waste, and salami slicing existing budgets tend to be the politicians’ stock answer, but none of these approaches go to the heart of the problem.  The problem is systemic.” The systemic nature of the problem means that the real drivers of government spending need to be addressed. This will require taking some tough choices, such as cutting the healthcare, schools and police budgets, means-testing the Child Benefit and abolishing other benefits such as the Winter Fuel Allowance, and increasing VAT on food and children’s clothing.

Reformers and Reactionaries

By Thomas Cawston, Researcher at Reform

Last week Reform made Andrew Lansley its “prestigious” Reactionary of the Week for his decision to halt the NHS London plan to redesign services to deliver quality care and reduce costs. Today we have our Reformer. The resignation of Sir Richard Sykes, Chair of NHS London, on account of Andrew Lansley’s decision, demonstrates the level of anxiety among NHS leaders about the Government’s health policy. Already the decision has echoes of Tony Blair’s and Frank Dobson’s decision in 1997 to dismantle some of the reforms of the previous Government.

Before the election there was a growing consensus in health policy that the NHS would have to undergo significant reconfiguration. As Reform’s March report Fewer hospitals, more competition argued, redesigning services is consistent with the long term change in health needs. The key challenge of a modern healthcare system is to improve the quality of life for people with long term conditions. This means the NHS needs new innovative ways to deliver treatment. Medicine has changed and health services need to change with them.

With the NHS facing a £20 billion funding gap by 2014 the case for service reconfiguration was indisputable. After years of consultation and research the Strategic Health Authority plans would have brought service redesign to deliver quality, innovation and productivity in the regional health system. This was the latest in a succession of reviews over the last few decades that have all advocated hospital closures.

NHS London led the way. London is facing £5 billion in real term cuts by 2017, with hospitals required to deliver savings of £2.4 billion. The capital has an unsustainable number of hospitals, as Sir Richard Sykes claims “the current configuration of hospital services is not making best use of taxpayers' money”. The SHA plan would have sought to reduce the number of hospital beds by a third and to close one in three A&E facilities. 75 per cent of all visits to casualty and 50 per cent of all out-patient appointments would be dealt with a network of 100 modern polyclinics. Only through these changes could the NHS in London reduce costs and improve services.

A better NHS does not require more money but local innovation

By David Botham, Intern, Reform

Saving money and improving care will be the holy grail of health reform in the next Parliament. At a Reform seminar this week leaders from University Hospitals Birmingham explained how they achieved quality and efficiency.

Rather than spending more or driving attempts to drive change from the centre. University Hospitals Birmingham brought real reform to the front line. Two initiatives made improvement possible. First, clinicians were made responsible and accountable for the care they delivered. This was rigorously enforced. The hospital has sacked more consultants than the rest of the NHS put together, including six in one go. Second, the hospital invested in an in-house designed IT system for prescribing information and patient records.

Now all staff have access to up to 1200 electronic patient charts at any one time through hand held tablet and mobile PCs. The benefits are clear and immediate.

In all instances errors are prevented at the point of decision:

• Improved infection control. Anyone testing as MRSA positive is immediately flagged by the system and automatically prescribed the appropriate drug therapy
• Patient charts show when a drug is being prescribed and by whom.

The IT system also monitors quality and efficiency through “clinical dashboards”, digital displays of up-to-date information on the running of hospital wards.

• These “clinical dashboards” allow efficient use of beds, as well as monitoring a patient’s length of stay and have allowed Birmingham’s Hospitals to reduce waiting times.
• Staff activity and efficiency is carefully monitored. Making clinicians accountable for their performance.
  
• There is also the capability of getting real time feedback from patients about the quality of care they are receiving.

 Birmingham Hospitals’ information revolution paved the way for increased productivity and reduced waiting times. Accountability and IT enabled clinicians to deliver better care and control costs.

How much would cancelling the NIC rise cost?

By Dr Patrick Nolan, Chief Economist, Reform

Earlier today Jonathan Isaby posted on the cost of cancelling the rise in national insurance contributions (NICs). This follows news that the Conservative party may pledge to halt on the 1 per cent rise in NICs. Halting the rise in these taxes is a policy that Reform has previously supported; indeed we have proposed going further and cutting these taxes through eliminating the exemptions in the VAT base. As we noted in Reality check the NICs increase will be a job killer and this approach of raising taxes on jobs is astonishing given a rise in unemployment of 22 per cent in the last year.

Reform has estimated the cost of cancelling the NIC rise and these follow (the estimates below are static only, so do not account for behavioural changes, and are thus likely to overstate the costs of halting this increase). These estimates are based on the Reform tax calculator which, unlike the Treasury’s ready reckoner, allows the revenue effect of changes to both rates and thresholds to be calculated. This is important as the government’s proposals are to both:

• Increase the employee primary rates (of 11% and 1%) and the employers’ primary rate (of 12.8%) by 1%; and
• Increase the primary threshold (currently £110 per week) to around £135. PBR 2008 proposed increasing this threshold to around £125 per week (equivalent to the level of the personal allowance) and this was taken further in PBR 2009 to help offset the increase in national insurance contribution rates for lower income workers.

Taken together these proposals are estimated to increase tax revenue by around £6.7 billion, not the £10 billion noted by some.

Thus, any proposals to halt the increase in national insurance contribution rates also need to consider whether to change the primary threshold (the income at which these contributions start being paid). Keeping the primary threshold at the current level of £110 would mean that halting the increase in the contribution rates would be more affordable, but would also mean that some lower income workers would face a higher overall national insurance bill than under current government plans.

This discussion highlights that governments have choices when it comes to setting different tax rates and thresholds – and when evaluating these choices it is important to see how the system as a whole impacts on families and government finances. Using the Reform tax calculator you can develop your own plans for reforming the income tax and national insurance system – so, if you think that taxes on jobs should be lower, how would you approach this reform?

PIGS should fly in the Chancellor's Budget

By Andrew Haldenby, Director, Reform.

The Chancellor’s Budget should follow the example of Portugal, Ireland, Greece and Spain, according to Reform's new Budget briefing.   The other heavily indebted members of the EU are already cutting their deficits by cutting the costs of the public sector workforce and cutting benefits and pensions.  These ideas should be at the heart of the programme to return the UK public finances to surplus which should start now and last for many years.

The Chancellor faces three tasks in Wednesday’s Budget.  The first is to eliminate the structural deficit in the UK public finances and return them to surplus.  The second is to secure economic growth and employment so that the cyclical part of the deficit is eliminated as well.  The third is to reform the UK public sector so that it achieves greater productivity even after the deficit is eliminated, allowing taxes to be reduced.

The other heavily indebted countries in the EU – Portugal, Greece, Ireland and Spain, also known as the PIGS – are already doing what the UK needs to do.  The great majority of public spending lies in benefits and the costs of the public sector workforce, so that is where the cuts must happen.  Each of these countries is reducing the costs of the public sector workforce by reductions in both pay, of up to 15 per cent, and headcount.  Portugal is increasing the means-testing of benefits and Ireland is reducing public sector pensions.

The need for a credible plan to restore the public finances

By Patrick Nolan, Chief Economist, Reform

One month ago on this blog Lucy Parsons and I argued for cutting government spending and for cutting soon. Arguments that a credible medium-term fiscal consolidation (spending cuts and tax rises) is necessary for a sustainable recovery have now been given extra force by John Lipsky, of the IMF, who has noted that:

"The projected government debt increase in the advanced economies is only partly due to discretionary fiscal stimulus. In fact, such measures has accounted for only about one-tenth of the projected debt increase. Thus, merely winding down the stimulus will not come close to bringing deficits and debt ratios back to prudent levels, considering the projected increases in health care of other entitlement spending.

"Addressing this fiscal challenge is a key near-term priority, as concerns about fiscal sustainability could undermine confidence in the economic recovery. Already in several countries with particularly high debt and deficits, sovereign risk premia have risen sharply, imposing strains for the countries affected and raising risks of possible broader spillovers. Over the medium term, large public debts could lead to high real interest rates and slower growth. We have estimated that maintaining public debt at its post-crisis levels could reduce potential growth in advanced economies by as much as ½ percentage point annually compared with pre-crisis performance."

Try your hand at being Chancellor of the Exchequer

By Dr Patrick Nolan, Chief Economist, Reform.

The Chancellor of the Exchequer faces a difficult task in putting together a Budget next week. Questions that the Budget will need to address include:

·         How can we convince the markets that there is a credible plan to reduce the deficit?

·         When should spending cuts begin – and what cuts can be made quickly (e.g., to the Child Trust Fund) and which ones will take time (e.g., some departmental budgets)?

·         How do we shore up revenues without damaging growth or weakening incentives to cut spending?

·         Is it possible to ring fence the largest areas of spending which have consumed the bulk of the increase in spending this century – or will ring fencing require cuts to non-ring fenced budgets (such as defence) that are too deep?

·         How do we avoid the temptation to use any reduction in the forecast levels of borrowing (which, to be fair, is at a dangerously high level) for vote buying measures, rather than doing the responsible thing and repaying debt?

·         How do we deal with interest groups who are already mobilising against reforms (such as to public service redundancy payments and education cuts) even though no real programme of cuts across government has begun?

So how would you approach the Budget if you were Chancellor? And do you think you could develop a plan that is better than those on offer from the political parties?

To help you to think through the revenue-raising side of this – how to shore up revenues without damaging growth or weakening incentives to cut spending – Reform has developed two calculators. One allows you to analyse how income taxes and National Insurance Contributions have increased so far this century and the other allows you to analyse what would happen if these taxes were reformed.

Fewer hospitals, more competition

Patrick Nolan, Chief Economist, Reform

The NHS occupies a unique place in British politics. MORI polling has shown that the most important issue to the country in this election campaign is the future of the service. As a result, as Andrew Haldenby and Nick Bosanquet have written, “Party leaders proclaim their lifelong love of it, MPs vow to fight for their local hospitals, but few dare spell out the difficult realities it faces – not least, unprecedented pressure on funding in the next few years.” But this political denial is doing no one any favours. It is time to have an honest debate on the NHS.

This honest debate should include discussion on the role that hospitals play in the health system.

The importance of change in health services can be shown by the example of coronary artery disease. Treatment used to require open heart bypass surgery – a costly and dangerous procedure which would require around a week in a hospital. Innovation now means that a more affordable and convenient treatment (angioplasty) is now available, meaning more people receive treatment and hospital stays are now only 48 hours. This treatment is being, in turn, replaced by pharmaceuticals (statins) which, when used as a preventative measures, reduces the need to enter hospital at all.

Next week’s Budget will mean that the poor state of the public finances will again come into focus. But debate around the Budget should not overlook the contribution of the NHS to the government’s financial woes. The NHS accounted for 40 per cent of the increase in inputs across the whole public sector between 1997 and 2007. Since 1997 spending on the NHS has doubled in real terms to £102 billion. One in every six pounds the government spends now goes on the health budget.

Recognising marriage in the tax system is bad policy

By Dr Patrick Nolan, Chief Economist, Reform

Lucy Parsons has written on CentreRight explaining how, given the appalling state of the public finances, it is time to take a fresh look at tax policy. Tax rises are an inevitable, although unwelcome (as comments on her article highlight), reality – with revenues needing to increases to reduce the deficit and to remind the electorate that the reckless public spending increases of recent years have to be paid for. But, as Lucy notes, tax rises must be held to a minimum (indeed Reform argues that rises must be lower than those proposed by all of the main political parties, including the Conservatives) and should be coupled with reductions in the most harmful taxes (such as National Insurance and the 50p rate).

Lucy also criticised the Conservative party policy of tax breaks for married couples. This may surprise some readers of this blog as there is a view that the UK, along with Mexico and Turkey, is one of only three countries that makes no recognition of marriage in the tax system. But this claim that the UK largely stands alone among industrialised countries in not recognising marriage is quite simply wrong.

There are a host of other countries that make no recognition of marriage in their tax systems at all, including New Zealand, Sweden, Finland, Greece and Hungary. Since the 1970s the clear direction of travel in tax systems has been to move away from family taxation. In relation to income taxes, for example, in 1970 it was possible to assess income taxes on a family basis in two thirds OECD countries, but in the 21th Century this has (quite rightly) fallen to around a third (and is continuing to fall).

Yet just because there is a growing international consensus against doing so does not automatically mean that recognising marriage in the tax system is wrong. It could be that this policy is right and governments in most industrialised countries are getting it wrong. But any rigorous assessment shows that this is not the case – plans to recognise marriage are poorly designed policy.

Lucy Parsons: Tax rises are inevitable - the debate should be about the least worst option

By Lucy Parsons, Senior Economics Researcher, Reform

Yesterday, Mark Hoban sacrificed breakfast to come and talk at a Reform event on tax.  For those readers unsure as to whether tax is something that would make them get out of bed early, Reform’s new report may give you a reason to think again.  The reality is that the scale of the public finances crisis is so great that tax rises are inevitable whatever the outcome of the election.

Indeed, taxes are already going up.  The Government’s proposals for the fiscal tightening are to raise about one pound in three from taxes.  George Osborne’s plans would mean around one pound in five.  Reform has argued for a smaller burden to fall on taxes.  Canada provides a good rule of thumb. The1995 Budget included CA$7 in spending reductions for every CA$1 increase in tax revenues.  The result was public support for the process of restoring the public finances – as the burden was on government getting its own house in order rather than placing the burden on taxpayers.  Applying this to the UK would mean extra taxes of around £12 billion, equivalent to £500 per family per year.

The honest debate that needs to be had is about how to raise this extra money.  The Government plans to raise £9.3 billion from the 50p rate and a 1 per cent increase in National Insurance Contributions from April 2011.  At a time when unemployment grew by 22 per cent in the last year, putting up taxes on labour is the most economically damaging way to go about it.  A recent CIPD/KPMG survey showed that one in eight employers was planning to recruit fewer staff because of the NICs increase.  FTSE 100 chairmen have described the 50p rate to Reform as the tipping point that stops the UK looking like a country that wants to attract business.

These are bad policies which should be abolished or reversed immediately.  The Opposition are wrong not to commit to doing this.  Tax policy is about choices.  There are far better ways that government can collect more revenue.

Making the case for cutting spending and cutting soon

By Patrick Nolan, Chief Economist, and Lucy Parsons, Senior Economic Researcher, Reform

Last week a debate between economists spilled over into the mainstream media. In the Sunday Times 20 economists signed a letter arguing that a credible medium-term fiscal consolidation (spending cuts and tax rises) is necessary for a sustainable recovery, that the current structural deficit should be eliminated over the course of a parliament, and fiscal measures should begin to take place in 2010-11. Later in the week an even bigger group of economists (67 this time) signed another letter arguing that these 20 economists were wrong and we should back the plans in the 2009 Pre Budget Report.

We got an insight into what the public may make of this public fall-out between economists when we spoke at a focus group on economic literacy at Demos this weekend. Demos invited 16 members of the public to hear economists argue on spending cuts from both sides – and we were there to make the case for cutting spending and cutting soon.

In making our case we emphasised that:

·         The deficit is more than just a debate between economists over numbers. The deficit has a real impact on everyone. Not tackling the deficit will lead to rising interest rates, currency instability and slower economic recovery. This will make it harder for individuals to borrow (meaning more expensive mortgages) and harder for businesses to borrow (meaning they cannot invest and hire more people).

·         The government’s finances can be thought of in a similar way to a family budget. The government gets income (from us all) in the form of taxes and other revenues. The government spends money on public services (e.g. NHS) and welfare (e.g. Child Trust Fund). When your income and spending don’t match, you save or borrow – so does government.

·         We have been living beyond our means for many years. Over the last 50 years governments have persistently spent more than they collected in taxes. Families have also been persistently spending more than they earn (think credit cards, overdrafts, mortgages). The government is now spending more on interest on its loans than on the transport and police budgets put together.

·         Some people argue spending cuts mean people stop spending money, leading to businesses cutting back production, leading to people stopping spending money, and on and on. However, this argument largely ignores how the money is spent – and the government tends to spend money more poorly than people would themselves – and that the money that government spends is not free. Taxing, borrowing and printing money all come at real costs – money does not grow on trees (and, if it did, it would be largely worthless).

·         Something needs to be done and we need to get on with it. Just like making the minimum repayment on a credit card, putting off repaying the debt will lead to the total amount we need to pay being higher. People who lend us money need to know that there is a plan for paying it back – otherwise interest rates will go up (which will mean mortgages will be more expensive).

·         When the money runs out, households prioritise their spending. The government needs to do this too and to focus spending on the right things, such as a more educated and efficient workforce and infrastructure (e.g. roads and utilities). Government plans are, however, to protect spending in the wrong areas (such as public service jobs) while infrastructure spending will be cut hardest. This is the wrong approach.

·         Some government spending is clearly being wasted or failing to provide a return that covers its costs of funds. In this case, why wouldn’t we cut this waste as soon as possible? Otherwise we would be simply throwing good money after bad.

·         Finally, although cutting spending in some areas will take time (e.g. given the need to consult with unions and staff) there is no excuse for not presenting a clear plan for reducing the deficit now.

So how did this all go down? When we asked the audience which politician has gone on record as saying we face some of the deepest cuts in spending in 20 years, the most common answer was David Cameron. No members of the audience identified a Labour politician (it was Alistair Darling) and that the Labour Party is planning major cuts. As Stephanie Flanders argued, in reality the difference in proposed spending cuts between the Conservative and Labour parties is slight (£15 billion by 2015-16, or 1% of GDP), but the perception of differences is much larger. All political parties are planning cuts soon after this year’s general election. The debate we should be having is how and where these cuts should take place.

Streamlining the police force

By Agneta Cederstrom, Intern, Reform

The inevitable spending cuts facing the public services have caused a wide-ranging debate, from the timing of the cuts, to ring-fencing certain departments, to preserving the “frontline”. Speaking at a Reform lunch seminar yesterday on the topic of saving money in the police service, Julie Spence, Chief Constable of Cambridgeshire Constabulary, wondered what preserving the frontline really means. She questioned the arbitrary nature of applying the frontline boundary at uniformed police, emphasising that back-office operations are themselves necessary to deliver “frontline services”.

This said there are a lot of efficiency measures which can be made in regards to information technology, financing, and human resources. By looking at the end-to-end process, one could remove duplication in such areas as call-handling or helicopter use, and minimise time wasted by police officers at the courts waiting to be called as a witness. There is scope to improve and rationalise within and across different parts of the criminal justice system, based on collaboration and information sharing.

Because criminal activity occurs across different geographical areas and levels of severity, there is no universal solution. The police have applied a “laminate model” which is based upon a tiered approach to law enforcement. This suggests that certain decisions be taken at a national level, whilst others such as procurement of vehicles and uniforms are made locally. In practice, however (and as Reform’s research has shown), this balance is not always right, with duplication between forces and inefficiencies created by a lack of consistency across the country. It was agreed, for example, that it makes sense for IT systems to be developed at a national level rather than separately by each of the 43 forces.

Schools for less?

By Dale Bassett, Senior Researcher, Reform

There is much ongoing discussion about whether and how to cut public spending, especially in universities (as the subject of cuts) and the NHS (as the subject of ringfencing). But no-one is talking about the second most expensive public service – schools. The Government has pledged to protect the schools budget; the Conservatives have not but are vague on specifics. A Reform lunch seminar today discussing how to save money in the schools system showed that there is a lot of scope to reduce costs.

Two things became immediately clear from the discussion – national funding arrangements will make it very difficult to uniformly trim schools’ budgets, and the amount of central direction and bureaucracy have played a major role in increasing the cost of schools in recent years.

John McIntosh, the former head of the London Oratory School, observed that the arbitrary nature of the funding system makes it difficult to impose a uniform percentage budget cut on every school. Huge variations in per-pupil funding (due to central prioritisation, various add-ons for pupils and schools and differences between local authorities) mean that a budget cut of 10 per cent would devastate some schools but barely impact at all on the curriculum of others. The current system, geared to reward failure, would mean that the best schools were the worst hit.

It is also apparent that while there are savings to made within any given school on, say, administration and procurement, this doesn’t get to the heart of the matter. The real problem is not “within” schools themselves; it is the national system that creates the excess costs that are borne by schools. The Every Child Matters agenda, national pay and conditions agreements and the Ofsted inspection regime all impose costs on schools and necessitate the creation of bureaucracies and management layers to respond to government initiatives.

One comprehensive school manager said that his school employs four full-time staff solely to prepare and analyse the data demanded by Ofsted. National agreements on “planning, preparation and assessment” time, class sizes and cover arrangements have resulted in a substantial increase in the staff-to-pupil ratio. A typical classroom in almost every primary school now contains two adults – the teacher and a teaching assistant. Meanwhile local authority control of funding and procurement makes it difficult for schools to achieve value for money in their purchasing of goods and services.

What is clear is that the wrong approach would be cutting 10 per cent off each school’s budget. Instead 10 per cent (or however much) should be cut off the total schools budget and national funding reform (John McIntosh proposed a national per-pupil amount) should be introduced alongside to ensure that some schools aren’t disproportionately hit. The result would be fairer and more efficient schools for all.

Look After Our NHS, or the Flat Earth Society

By Nick Seddon, Deputy Director of Reform

The Flat Earth Society took a bit of a hit when satellite images taken from outer space showed the earth as a sphere rather than flat, but they weren’t fazed. The Englishman Samuel Shenton, who ran the modern organisation in 1956, remarked: "It's easy to see how a photograph like that could fool the untrained eye." There’s nothing new to the belief that the earth is flat, of course. Indeed, it was almost universally held until as late as 4BC. Then the likes of Aristotle started to provide evidence of a spherical earth, and by the Renaissance it was widespread knowledge throughout Europe that the Earth was a sphere, especially thanks to the likes of Galileo. The best headlines of the cult Flat Earth News during the '70s and early '80s included "Galileo Was a Liar" and “World IS Flat, and That's That". Sadly, although there are some websites for this seriously retro club, the society seems to have been disbanded in the early years of this century. It’s probably around this time that some of its members started to join the top ranks of the British Medical Association.

If you want to laugh, you should turn on your computer, turn up the volume, make a cup of tea and watch this animated cartoon, Look After Our NHS. That’s right, the venerable British Medical Association, once one of the most vehement opponents of the NHS – they called Bevan a “medical Fuehrer” and said that nationalising hospitals represented “the greatest seizure of property since Henry VIII confiscated the monasteries” – is launching one of the most comical campaigns ever. Viscerally and ideologically against markets, they argue that the NHS’s financial challenges will be overcome by “abandoning this market in healthcare”. Let’s not worry too much about the fact that there isn’t a market in healthcare – it’s the policy direction, but implementation through central diktat rather than real competition has short circuited the system. Let’s not worry too much about whose NHS it is either – it’s for the patients to decide who looks after them, and they don’t seem to mind whether they’re treated privately or publicly so long as it’s high quality and dignified.

No, let’s just take a moment to think about markets. We’ve become used to lifestyles and possessions that a previous generation couldn’t have conceived of and ordinary people have become accustomed to choice, variety and responsiveness to their demands. Just think about how markets, aligned with scientific and technology, have changed our world for the better. In the 1980s, cars used to break down. People used to moan about it all the time. And British Leyland did nothing about it. And then along came some healthy international competition from the Far East, with some six sigma advances. When did your car last break down? Indeed, think about any sector you care to that has undergone a revolution. Think about telephony – do you remember how expensive it used to be to make international calls? – before fibre optic cables. Think about food production and distribution.

Fairytales like a ‘Robin Hood Tax’ won’t help anyone

By Patrick Nolan, Chief Economist, Reform

A coalition of domestic charities, aid agencies, unions, faith organisations and green groups has proposed a global tax on financial transactions to help “fight poverty, protect public services and tackle climate change”. This tax is based on an academic idea that has never worked in practice. The idea was first proposed by James Tobin, who was awarded the Swedish Bank Prize in Economic Science (Nobel Prize), but not for this.

The Tobin tax would work by charging a tax every time people exchange currencies. Some advocates believe that given the large number of currency transactions that take place every day this tax would generate almost endless revenue and reduce currency speculation, which would benefit the economy. But these views are little more than a fairytale.

In the almost 40 years since a Tobin tax was first proposed this idea that has never gotten off the ground. The reason for this is simple – it will never work. For it to work it would require every tax jurisdictions to agree on it. But the international community struggles to agree on trade talks (such as the failed Doha round) or on climate change (COP 15 in Copenhagen), so the idea that an international consensus will arise over a tax issue is hopelessly naive.

Where international tax negotiations have shown promise is in areas where there is a real prospect for success. The IMF, US, UK and other major European economies are, for example, investigating an insurance levy on banks to protect against another financial crisis, which is very different from taxing currency exchanges to fund extra public spending.

There would also be significant harm to the economy from a Tobin tax. Economic volatility would increase as currency exchange is a central part of many important activities, such as exporting. Many currency transactions are for ‘insurance purposes’, such as exporting firms ‘hedging’ against the possible movements in exchange rates between the time a contract is agreed and the time when they finally get paid. Presumably when you next take an overseas holiday you would also pay the Tobin tax when you purchase some spending money at the airport. Ordinary people and businesses will pay this tax.

Finally, an additional tax fails to address the problem of poor quality government spending. In relation to ‘fighting domestic poverty’, for example, the UK already has one of the most expensive welfare states in the developed world, but performs poorly as much money goes to people not in need (middle class welfare costs around £31 billion a year). Underperformance not underfunding is the real problem facing the welfare system and public services. Indeed, as Sir Roger Douglas, former New Zealand Chancellor of the Exchequer has argued:

"[Voters] seem to have bought the false notion that we can all be made wealthy through government. Elections have become an opportunity for politicians to promise they will take more money off you, only to give it back to you in another way – a gold card for superannuitants [pensions], a tax credit for working families, or an interest write off for students. If we each pretend that we can be made wealthy through taxing others, then we’re destined for poverty. We are increasingly relying on others – be they foreign lenders or domestic taxpayers – to sustain our way of life."

These are challenging times for the public finances in the UK and abroad. However, fairytale tax policies will do nothing to address the problems we face in the real world. We need adult thinking, not children’s bedtime stories. The advocates of the Robin Hood tax would be doing themselves, and us all, a favour if they left the fairytales at home and based their thinking on some real classics in public finance, starting with Richard and Peggy Musgrave and James M Buchanan.

A thoughtful evening on the south bank

By Dale Bassett, Senior Researcher, Reform

Last night Patrick Nolan and I had great fun at the sold-out Southbank Centre “Think Tank Clash”, organised by New Deal of the Mind. Eight leading think tanks from left and right came together to debate some of the key issues of the day in a very enjoyable evening hosted by Rory Bremner (who warmed up by treating the speakers to his own take on the Chilcot Inquiry in the green room beforehand).

The organisers deserve great credit for creating a different type of event with punchy debate and a genuine clash of ideas, even if I can’t help thinking that the audience weren’t entirely representative of the views of the population at large!

The four debates were fascinating, although not perhaps entirely focused on the needs of the policy debate at this moment. Jessica Asato of Progress tried valiantly but failed to win over Phillip Blond’s enthusiasm for Red Toryism. Matthew Taylor and Richard Reeves had an absorbing if abstract debate on the importance of character versus social networks, while Policy Exchange’s Andrew Lilico and the IEA’s Philip Booth took on Carey Oppenheim of the IPPR on the great question of market versus state.

The Reform team was fortunate enough to have perhaps the most topical debate of the night, arguing against Sunder Katwala of the Fabians and the Telegraph’s Mary Riddell on the topic of universal welfare. Patrick and I set out the case against, citing our research which shows that universal benefits effectively create an unaffordable £31 billion subsidy for the middle classes. But Sunder and Mary won the audience round with the appealing idea that we can “have it all”, with higher taxes and higher benefits ensuring no-one gets left behind.

The format – pitching left against right in each of the four debates with the (generally left-leaning) winners going through to a final debate on the economy – meant that the latter part of the evening was dominated by a discussion not entirely rooted in the fiscal reality facing the country today. To their credit, Phillip Blond argued for cuts to the health and education budgets and Matthew Taylor called for “mature” citizens to realise that they can’t in fact have it all. Judging by the audience’s votes, though, we still have work to do to get that message through.

Universities: the lone recipients of political leadership

By Dale Bassett, Senior Researcher, Reform

All parties are now united on the need to cut public spending to reduce the deficit.  But details on individual budgets have been scanty.

But one area of policy has seen all the urgency and all the political leadership that anyone would want to see – the universities budget. Since December, Lord Mandelson has announced reductions in university and research funding that, the Higher Education Funding Council revealed yesterday, will amount to £449 million next year.

The Government has taken the right approach.  It has realised that cutting spending does not have to decrease the quality of service.  It has faced down the vested interests in the system and has not been afraid to criticise overreaction.  It has floated new ideas for increasing the efficiency of the sector, such as Lord Mandelson’s suggestion that more degrees could be taught in two years rather than three.  It is regrettable that the Opposition has offered such an unhelpful response.

Lord Browne’s review, which will report after the election, will almost certainly conclude that a bigger role for private contributions will help to safeguard our universities.  Higher fees and a revised student support package will allow universities to increase provision while easing the strain on the public purse.

These are encouraging signs. There is no doubt that universities can get more bang for their buck, and the cuts that have been made in this area are proof that political leadership does work.  It raises the question: if politicians can show leadership and innovation, take on entrenched interests and involve more private finance in the provision of universities, why can’t they do it for every public service?

Automatic stabilisers yes; one-off stimulus no

By Andrew Haldenby, Director, Reform.

 

One of the big questions of the moment is whether to cut public spending or whether to push even more fiscal stimulus into the economy.  A useful meeting in Westminster yesterday generated some answers.  A hundred Treasury, Bank of England and Number 10 Downing Street officials, City economists and academics gathered to discuss the output of the World Economy and Finance Programme, comprising the work of many academics led by Professor John Driffill of Birkbeck College.

The most important session for Reform’s work on public spending, and for the big political questions, was that on fiscal policy, introduced by Simon Wren-Lewis of Oxford University and George Alogoskoufis of the Athens University of Economics and Business (and the Minister of Economy and Finance of Greece until January last year).

The academic research was strongly against temporary fiscal stimulus.  The presenters argued that government spending should certainly rise in times of economic slowdown – but this should be achieved through the “automatic stabilisers” i.e. the automatic payments that governments make in hard times, such as extra unemployment benefits.  The great advantage of these is that they fall away of their own accord as growth picks up and unemployment falls.  Both speakers criticised one-off stimuli on the grounds that they may be politically difficult to withdraw.  This supports the finding of previous Reform research.

A better system of parental leave requires real reform, not more spending

By Patrick Nolan, Chief Economist, Reform

The government has revived the proposal for fathers to be eligible for six months of paternity leave while their baby’s mother returns to work. The government is not alone in looking for ways to help reconcile the challenges facing working families with young children, with the Liberal Democrats proposing 19 months of more generous parental leave (able to be taken by any parent) and the Conservative Party proposing flexible parental leave to help make Britain more family friendly.

The government’s proposal has, understandably, caused concern among business groups. One reason for this concern is the costs to businesses of administering this proposal – as it will require employers to monitor the leave use and entitlement of the spouse that does not work for them.

Indeed, the costs of administering the proposal alone were identified as between £8.4 million to £12.2 million in the first year, with businesses facing £1.8 million to £5.6 million of these costs. This is before we add in the direct costs of paying extra paternity pay, which could be around £500 million per year.

In an era when the UK is facing the toughest spending cuts for 20 years, this proposal is quite simply unaffordable. But more importantly this proposal also illustrates that current policy on reconciling work-life balance is stuck in a rut. Spending more money and extending the existing offer will not address the underlying problems in the existing system of statutory maternity and paternity pay – a new approach is needed.