The Greatest Democracy on Earth

The United States is often marketed as the Greatest Democracy on Earth. I’m not sure I agree.

A couple of months ago there was a lot of worry in the global markets that the US was about to default on its debt. As I wrote about here, this was a very different situation to that of Greece who is very much in danger of default at the moment.

So, why is it different? After all, both of them need money. Let’s take a look.

The USA

Investors are banging on the door to lend the US more money.

Greece

Finding someone who wants to lend to Greece at the moment is harder than finding a dodo who can simultaneously breakdance, juggle six elephants and recite its seven times table in Welsh.

While both countries need money, investors believe that the US will be able to pay it back and Greece won’t. It is probably not a bad judgment.

So if the US isn’t a risk to lend to, if people are queuing up to lend it money – why was there ever talk of a default?

To understand this we need to look at US politicians. In the US (to all intents and purposes) there are just two parties, the Democrats and the Republicans and things are always very close between the two. With nothing to back this up, I am going to lazily say that 45% of the US public always vote Republican and 45% always vote Democrat. The remaining 10% decide who is in government and even they are often fairly evenly split.

Because of this the US always has a fairly evenly split Senate, which in turn leads to both parties needing to agree in order to pass changes to US policy. There’s nothing wrong with this in theory; in some ways it is quite good but it does require that to get anything done the two parties need to work together in a reasonably constructive manner.

That’s where the problem lies – they can’t. Or at least they don’t.

The President of the United States, is often referred to as the most powerful person in the world. Evidence clearly shows this is far from true. Take that “almost default” example. Without the Senate agreeing, Obama couldn’t even make the decision to take the money that the US needed and not default on their debt repayments.

Instead the decision went to the Senate.

Defaulting on your debt when people want to lend you money very cheaply would be more than a bit daft. In fact it would be so daft that even the Republicans knew it would be much worse for the US than just borrowing the money that people wanted to lend it.

The Republicans also know though, that their votes are needed for the decision to pass so instead of just saying “Fine borrow the money, let’s move on to something important.” They instead said, “You can borrow the money only if you do something totally unrelated that we want.”

(For more on that read my charming, metaphorical story about Obama flying an aeroplane. Or should that be an “airplane”?)

Had the bill not passed, the people who would have lost out would firstly have been the US citizens as their economy went down the pan. Then everyone else in the world would have been in trouble (as the health of the US economy affects us all).

Although there was a lot of posturing and political bravdo thrown around by both sides, that situation can be neatly summarised like this:

The Republican Party held the US government to ransom with the American people as the hostages.

I’m not being theatrical, this is simply what happened. The Republicans wanted some spending cuts and held the country ransome to get them and it was truly shameful. A far better way of doing things (without causing global economic chaos) would have been to say:

“We all agree that we need to borrow some more and while we would like to discuss other fiscal measures we will do so once this is sorted out. After all whatever we agree on those items, paying our bills is essential.”

Unfortunately this isn’t a one off. Obama has recently announced a new bill aimed at boosting the US economy through closing tax loopholes for the wealthy and increasing government spending. It is actually a very sensible bill but it doesn’t matter – it will be shot down by the Republicans and it won’t pass.

Is that stupid? No, it is ludicrous. Republicans, hate taxes on rich people and hate government spending. Their political campaigns are funded by the rich and that is of more interest to them than doing something sensible to actually help sort out the problem.

The US government needs to act decisively but can’t because of their politicians and sadly, their economy will experience far lower growth than it should do and we’ll all be worse off because of it.

Have you ever wondered why the US can’t bring in public health care or cut greenhouse gas emissions? Same reason – any sensible policy can be easily blocked by a few right-wing half-wits with their own agenda.

In light of this, is the US the greatest democracy on Earth or a bit of a fucking mess?

It’s not just the US though. Europe is in a big mess too. Do you see any sign of some decisive action from European politicians to put forward a clear plan to sort their mess out? If you’ve spotted one then let me know, it must have passed me by.

Politicians just don’t seem to realise that part of the remit we gave them when we elected them was to be able to sort this stuff out. In the US, Obama is trying but he’s ultimately powerless in achieving anything. In Europe they’re doing nothing and hoping it blows over. (It won’t.)

So what of the UK? The UK government has favoured spending cuts and austerity over any attempt to boost the economy. With interest rates at the zero lower bound and unable to be cut further to offset the cuts, this is at best a dangerous game. Basic economics shows that spending cuts in such a situation will harm growth but the government crossed their fingers and hoped that the economy would somehow sort itself out on its own. In the long run it probably will but that’s hardly a reason to dismiss opportunities to sort things out now.

The IMF has said that if the UK is not going to meet the government’s 2011 economic growth targets (it doesn’t have a chance by the way) that it should reconsider its policy of spending cuts and look instead at a policy of stimulating the economy.

After the election in 2010 it would have been very difficult for any political party to forsee the future and build the perfect fiscal policy to cope with such unknowns. In such circumstances, the elected government should:

– Have used macroeconomic theory as the foundation for their policies. (They didn’t)

– Absolutely be prepared to adapt their policies to match the continually changing and unpredictable economic climate. (They aren’t.)

The government based their policy of spending cuts on the hope that economic growth would happen anyway. It hasn’t and now is the time for them to understand that blindly pursuing this will only cause further harm to the economy.

When looked at objectively, the ability to assess and adapt seems like common sense but asking a politician to consider changing policy is not so simple. A lot of that is our own fault. When a government changes its policy we all say, “It’s a U-turn! You got it wrong! You’re rubbish!”

That really is missing the point. An effective government will not be made up of fortune tellers. Therefore an effective govrnment needs to be able to continually adapt their policies to fit with a volatile and unpredictable world. If, next week, George Osborne says that he is going to scrap some cuts and instead focus on some policies to stimulate the economy, we should not all be criticising him as a weak policitian for changing his mind. If he does this we should be commending him as a strong politician – someone who is able to adapt their policies to fit the situation in which they find themselves.

Of course this is all wishful thinking. In reality what will happen next week is that:

  • Obama will bang his head against a wall because the Republicans will block his sensible policies
  • Angela Merkel will keep her head in the sand and hope it all goes away
  • George Osborne will fly in the face of logic and stick with spending cuts

The really sad thing is that now, more than any time in the last three years, it is easier to know what a good fiscal policy is.

It just seems harder than ever for a politican to spot one.

RedEaredRabbit

The Tax Delusion

Have you ever met a climate change denier? I wonder why they don’t believe in global warming. Using some fairly basic maths you can calculate the Earth’s surface temperature assuming no greenhouse effect exists – it’s about minus 18°C. The reason we’re not in a permanent ice age is because of the greenhouse effect.

“Rubbish!”  you say, “the greenhouse effect is something new, we didn’t have it before and it wasn’t that cold!”

The greenhouse effect is actually nothing new – it’s been around as long as carbon dioxide, water vapour and other greenhouse gases have existed in our atmosphere. The problem now is that our activities are increasing the concentration of these gases. Basic physics states that this should increase the Earth’s surface temperature and lo and behold that’s exactly what we observe. Of course there are many factors that affect our climate at any one time and while we cannot be 100% sure how much the greenhouse effect will affect the surface temperature in any one given year, we can be sure of these two facts, which are absolutely indisputable:

a) We are increasing the concentration of greenhouse gases in the atmosphere

b) Greenhouse gases increase the surface temperature of the planet

When the temperature starts going up in line with this it is surprising that lots of people choose to put their heads in the sand and deny what theory and evidence shows is very clearly happening. The reason I think, that this denial-phenonmenon exists, is simply that it is much more convenient for people to live in denial than it is for them to accept reality.

Accepting the true scale of the problem means significantly changing our lifestyles and a lot of people don’t want to do that. Pretending that climate-change skepticism has any basis outside cloud-cuckoo land allows people to continue doing what they’re doing and avoiding this massive inconvenience.

This blog isn’t about climate change though.

Have you ever met a supply-sider? Supply-siders have a lot in common with climate change deniers. I should explain what I mean by a supply-sider. It’s about tax though, so grab a coffee before you continue.

Cutting income tax has a positive effect on economic growth because people have more incentive to work and have more disposable income to spend. The problem though is that tax cuts need to be financed by cutting public spending and that has a negative effect on economic growth and a negative effect on people’s quality of life. As an alternative to cutting spending, we could borrow to cover short-term tax cuts but we can’t make permanent tax cuts and still have a functioning NHS, education system, armed forces etc. etc.

That much is, again, basic maths and uncontroversial. Unless you are a supply-sider. Supply-siders believe that the effects of tax cuts is so ridiculously large that they more than pay for themselves – that cutting taxes actually increases government revenue and everyone becomes better off because of it.

Nowhere are supply-siders more prominent and militant than in America. When Bill Clinton took office he took over a large budget deficit. He responded to this by introducing tax rises on the middle-classes and wealthy. Supply-siders went mad – claiming that this would starve the economy and usher in financial disaster! In fact what happened was that the economy grew, unemployment went down and the deficit turned into a surplus.

Enter George W. Bush. As a supply-sider, Bush brought in an era of tax cuts and the richer you were, the more you benefitted. This, he assured everyone would make a massive boost to the economy. The surplus quickly turned back into a massive deficit.

Of course these are just two examples (albeit good ones) and there were many other things going on which would have contributed to these two outcomes. Importantly though, supply-siders said that Clinton’s policy to raise taxes on rich people to pay off the deficit would spectacularly backfire and they said Bush’s policy to cut taxes on rich people would boost the economy. In both cases they were 100% wrong.

Like, climate-change deniers, supply-siders ignore logic and evidence simply because the reality is inconvenient. Supply-siders organise huge campaigns to tell voters that their taxes are harming the economy.  They tell people that if they just paid less tax to the government and kept more money for themselves, we’d all be better off. This is voodoo economics. This is one of the ultimate examples of bad marketing. This is to economics what homeopathy is to medicine.

So we can see that while cutting taxes stimulates economic growth, it does not pay for itself. Cutting taxes will cost money and if it is the rich receiving the benefit, it is everyone else who is receiving the cost of it.

It was therefore, with sadness that I read this week’s story about 20 economists writing to the FT to campaign for a lowering of the top tax rate, stating that it was harming the economy.

I do agree we need something to stimulate the economy. As I’ve discussed before on here – we won’t get rid of the deficit without economic growth and there is precious little of it at the moment. I do though have a big problem with attempting to do this through a tax cut on the 320,000 richest people in the country. Don’t misunderstand me – I am not so much of a liberal that I want to advocate the punishment of rich people, I simply think that if you are in the top 320,000 richest people in the country you should not be at the front of the queue when it comes to government handouts.

The supply-siders’ excuse is that by giving rich people even more money we will boost the economy and it will filter down to the poor people.

So which of these boosts the economy more?

a) Giving 10 rich people £1,000,000 each

b) Giving a million poor people £10 each

The letter to the FT offered nothing more than vague anecdote to say why we should go for a). 24% of income tax, it said, is paid by the richest 1%. This could be because taxes are grossly unfair. It isn’t though.

The income gap between rich and poor has been rising for a long time and is now bigger than it has ever been. When a small number of people earn lots of the income, a small number of people pay lots of the income tax. On its own, that figure of 24% paid by 1% tells us nothing useful at all. (I wrote more about this here.)

I reread the letter a few times and couldn’t really understand how 20 economists (a few of them with senior academic positions) could so strongly advocate such a tax cut and only provide a weak argument of vague anecdote to back it up.

To say the least it was a wish-washy argument: “Some rich people might all move somewhere else with a lower tax rate.” Well they might indeed – we all understand incentives. I would have thought though – no I would absolutely have expected that 20 economists arguing for tax cuts for rich people, between them could have come up with something concrete to show why, in the circumstances, this is a good policy. The US has (and has had for a long time) a far lower top income tax rate compared with the large economies in Europe and they’re doing worse than we are. I haven’t see a huge number of UK companies abandoning ship and moving to the US.

Supply-siders argue that when taxes on top-earners are raised that top-earners find ways to avoid and evade the taxes. That’s also true, but it isn’t necessarily a reason to sort it out through a policy of:

“Damn those rich people, they’re so wiley! We’ll have to recoup that money from the less-wiley poor people!”

If our tax rules are this easily side-stepped by rich people then we should look at the tax rules and make them tighter. We should not be saying that poor people should be picking up the bill because we have loop-holes in our tax law.

A very important point that the letter ignored though is what people do with the extra money they receive through tax cuts. If we go with option a) and give 10 rich people £1,000,000 they might spend a bit of it but most likely a lot will go into their savings – they already have plenty of money to finance their lifestyles.

If we go with option b) and give 1,000,000 poor people £10 each they will spend it. When people are really struggling to get by on what they earn they don’t open a savings account.

This is very important because the key reason that tax cuts help to stimulate an economy is because people have more money to spend and in spending that money they stimulate the economy. If we make a tax cut where the extra money goes straight into people’s bank accounts then no economic growth is realised. These are two very basic and indisputable economic rules:

  • Rich people save a greater proportion of their income than poor people
  • Spending money stimulates the economy
It is therefore absolutely the case that option b) would lead to more of the realised tax benefits being pumped back into the economy. Wouldn’t it be a good idea to have at least mentioned this in the letter? Maybe shown how they could be so sure that the effect of the disappearing, tax avoiding rich people outweighed this effect?

Anyway, as it transpired, the 20 economists’ letter to the FT had been organised by a PR company. I’ve no idea why a PR company decided to set out to find 20 economists to sign their letter but something fishy is definitely going on.

Labour’s alternative is to make a temporary cut in VAT. This might work quite well as an economic boost – everything is cheaper for a year, buy it now! It isn’t a perfect way of targeting the poorest – VAT has a reasonably equal effect on everyone. The Lib Dems (remember them?) are said to favour raising the threshold below which no income tax is paid to £10,000. I like that one the best.

Let’s be clear, though – none of these ideas is going to suddenly pay for itself. Despite the claims of the supply-siders, all tax reduction policies would increase the deficit (or mean additional, unplanned spending cuts.) While increasing the already massive deficit is not ideal, I would be in favour of doing so if it kick-started some growth and simultaneously helped out the poorest people who are struggling the most.

If, when you started off reading this blog post you were an advocate of tax cuts for the rich and are now considering your position then this post has done its job.

If, when you started off reading this blog post you were an advocate of tax cuts for the rich and are not now considering your position then don’t worry, you’re not on your own – George W. Bush is on your side too.

RedEaredRabbit

Scotland and Filettino

Yesterday I read this rather wonderful story in which the Italian town of Filettino, population 550, has declared independence from the rest of Italy in protest at the government’s austerity measures.

This got me thinking about whether the move was in fact a good one. Sure Berlusconi isn’t running things for them now but he has been replaced by someone whose first act was to print bank notes with his own face on so the jury will have to remain out on the leadership point for now.

Since I don’t know too much about Filettino, I decided to first think about a more familiar independence argument – should Scotland be independent from the United Kingdom? I wasn’t sure about this either so I do what I always do in such situations – I asked Twitter. I also cunningly asked respondees to give me their nationality.

These were the results:

Votes for Independence for Scotland

Overall things are a bit mixed but we can say that the Scottish respondees were mostly against independence and everyone else was split about evenly. (Except in North America where Canadians were 100% against independence and US was 100% in favour. It was a small sample though.)

Quite a few of the English Yes votes were accompanied by a brief “we should stop paying for them” type quote. This always seems to be what the argument boils down to but the SNP argues that Scotland more than pays its way because of North Sea Oil.

Let’s look at this. If Scotland became independent and international waters were divided up according to standard methods then they would certainly have a far larger share of the North Sea oil per head of population than England. Scotland isn’t Abu Dhabi though, so is it enough for them to successfully function independently?

The price of oil is hugely volatile. It varies between $50 and $150 a barrel and seems to shoot between these two extremes all the time. Major oil producers like Abu Dhabi hold lots of oil in reserve and actually help to set the oil price by controlling its supply into the market. Scotland could not do that – if it based its economic independence on oil then it would have a very volatile income. Because the UK economy is much larger than an independent Scottish economy, this volatility in the oil price has a much lower effect on it. Scotland could however, get around this through borrowing money when the oil prices were low and paying it back when oil prices were high, it’s a more expensive way of doing things but probably not a big issue.

You could though, argue that oil is going to run out at some point and that relying on it for your income is not a particularly clever long term strategy. That’s true but like it or not, oil will be around for a while yet and there would be plenty of time for an independent Scotland to invest in other industries before the oil is all gone.

Anyway, back to the key question – is the rest of the UK funding Scotland or vice versa? More or Less on Radio 4 recently did the maths. They calculated that over the past 27 years Scotland had been subsidised by the rest of the UK to the tune of £20 billion. It might sound like a lot but £20 billion over 27 years is nigh on nothing. It’s about £741m per year, or to look at it another way it is equivalent to 20 tonnes of platinum at today’s prices. 20 tonnes of platinum is handily pretty much exactly a block of one cubic metre. (One cubic metre of platinum weighs 20 tonnes! Pretty cool, no? No? Oh.)

Why is that nothing to worry about? Last year the UK as a whole borrowed the equivalent of more than twice the height of Big Ben in such blocks – one block really isn’t an argument defining amount.

(If you just read that and said, “Actually Big Ben is the bell, not the clocktower, this RedEaredRabbit is an idiot!” then you are both a pedant and a poo.)

My point is that in reality, the rest of the UK does not fund Scotland and Scotland does not fund the rest of the UK. Ok, the rest of the UK funds it a little bit but everywhere outside London is like that. London is a huge, global financial centre – why should we not expect it to generate more money per head than other parts of the country? Of course it will. Accepting this is not having a dig at any particular region, it is just obviously going to be the case. On the other hand, saying that because London does produce a lot of money, it should keep it all for itself and not give anything to the rest of the country is frankly, a bit silly.

So we can see that with all things average, Scotland can take care of itself financially. Sadly though – things are not always average and I think an independent Scottish economy would have struggled more during the financial crisis than the UK economy has – not least because its two major banks HBOS and RBS failed in the most spectacular fashion. In tough times, being part of a major economy, with access to borrow an awful lot of money cheaply is very handy and that is probably my biggest economic argument for Scotland to stay as part of the UK.

I got sidetracked massively then. I was talking about Italy.

So then, what of Filettino? Well Italy’s national debt is about €31,000 per person and it’s going up all the time. I don’t really see that Filettino can declare independence and avoid taking its share of the debt so now the 550 people in Filettino need to pay off €17m on their own. If the town has a (very) disproportionately large economy then they can do this and they might be ok. If they don’t though they are going to find it extremely hard to continue borrowing at any reasonable rate. Although it’s a fun story, I can’t help thinking that the motives behind it were based less on economics and more on a crazy mayor with a power trip.

In conclusion, I don’t see economic benefit to a declaration of independence in either of these two situations but economics isn’t everything. I’ve grown up in the United Kingdom, I love it and I love all four countries. Of course they each have their own history and culture – I would never want it any other way and I think it’s a big part of what the UK is.

From my perspective, without any one of the four countries, it just wouldn’t be the UK any more. If Scotland receives a tiny bit more money one year and then pays a tiny bit more money the next year, should we really be talking about splitting up over it? I don’t think so.

I think we’re pretty good at the moment.

Besides which, when Andy Murray wins Wimbledon next year I want to claim some of the glory for myself.

RedEaredRabbit