Saturday, 21 September 2013

Is This a Tax or a Subsidy I See Before Me?

So Edward Samuel Miliband, the leader of the Labour Party, has finally promised to abolish the spare room tax, or should that be the spare room subsidy?  I’m not entirely clear.  Every Labour party politician assiduously refers to this as the spare room tax and every member of the Conservative party assiduously refers to the spare room subsidy. Their various supporters in the press follow suit, so which is it?  In essence, this is about the use of language to bias a debate.

  • If it is a tax being imposed on poor people, then that is more evidence that the people imposing it are heartless Tories.
  • If it is a subsidy being withdrawn, then that is further evidence that people who oppose the policy just want to spend money and would explode the deficit if they got power.

This kind of labelling is an old (and quite transparent) trick, and one that I have already used twice in this post alone (although you may have to know what my own political bias is in order to spot one of them).

Technically speaking, I have more sympathy with the Conservative description of the policy as what is happening is that a subsidy is reduced if the family living in subsidised accommodation is judged to have more than sufficient living space.  I suspect some quick witted Conservatives will start saying “there he goes again making promises he can’t keep: You can’t abolish a tax that doesn’t exist.” 

Although withdrawal of a subsidy can have effects similar to the imposition of a tax.  Indeed, a subsidy is simply a negative tax rate, and so there is a point that if a subsidy is reduced, that is mathematically the same as increasing a tax. This often leads some people to cast a reduction in tax rates, or a refusal to tax a good they think should be taxed as subsidising the good in question.

The problem with using this logic to cast the failure to impose taxes you like as a subsidy and the failure to give out a subsidy you like as a tax is that it is highly vulnerable to reductio ad absurdum.  A friend and I were once discussing an article which referred to the withdrawal of a tax on mortgages (which happened about 20 years ago) as a subsidy for private home owners. At the time we were sitting in Oxford’s economics department which is one of those buildings where all the external walls are made of floor to ceiling windows, so I had to point out that the abolition of the Window tax in 1851 meant we were in the most subsidised building in Oxford.  Indeed, under that view, the Shard of Glass in London is receiving an eye wateringly large subsidy (adjusting the taxes that were charged for inflation).

To go one step further into the absurd, before breakfast, I could claim that books have been heavily subsidised by the government’s failure to tax them at £1,000 per book. After breakfast, I can claim that books have been heavily taxed by the government’s failure to subsidise each book by £1,000. The only thing that has actually changed while I was having breakfast is my reference price, not the policy.

So there must be some reference where we can refer to the good as either being taxed or subsidised.  One extremely convenient one would simply be to look at whether the government is paying out money (in which case we should probably refer to a subsidy) or whether the government is taking in money (in which case we should probably refer to a tax).  The key advantage of this way of labelling things is simplicity, to know whether a policy is a subsidy or a tax, you just need to look at what happens to the government’s budget. Under this convention, the Conservatives are correct and the housing benefit changes constitute a reduction in subsidy rather than an increase in tax.

However there is another way of looking at this which allows us to be more sympathetic to Labour. We could say that a policy is a tax if it raises the price above the market price that would prevail if there were no market imperfections, and that it is a subsidy if it lowers the price below the one that would prevail if there were no market imperfections. One attractive property of this way of labelling policies is that we can refer to the refusal to tax petrol in a manner that takes the price of the carbon externality into account as a subsidy.  In this labelling scheme, any policy that involves any kind of subsidy or tax is per se inefficient. Since the price of housing in the UK is kept artificially high by imperfections in the housing market, this would allow us to cast the benefit changes as a tax and say that Mr. Miliband is correct to talk about abolishing the bedroom tax.

If this labelling scheme appeals to you, then I just have one question for you and Mr. Miliband: So you are going to be taxing those who are ineligible for housing benefit how much?

I thought so. It is probably best if we just stick with the definitions of tax and subsidy that refer to the effect on government spending and income. 

None of this makes any comment on whether reducing housing benefit in this way is the correct policy, it is just about whether we should call it a tax or a cut in subsidy. Now might be a good time to start openly discussing the merits of this particular subsidy and whether it should be reduced or not; and if it should be reduced, is this the right way to go about it?

Friday, 20 September 2013

Pampered or Rational?

So a recent post about why Generation Y is so miserable caused a bit of a fuss recently, and a response can be found here. I’m not going to try and endorse or deny the stuff about entitlement. For one thing I am of Generation Y myself, so if I bite on that bait, I will only be providing evidence for the other comment about Generation Y that they don’t respond well to negative feedback. My main point is simply as follows: The trends identified in the “waitbutwhy” article are actually rational responses to a changing work environment. In particular pensions used to provide incentives which dramatically increased the financial value of careers which would give rewards only after many years’ hard work. I don’t want to get drawn into too much of the institutional detail here, if for no other reason than that those details differ on different sides of the Atlantic, so I’m afraid it is going to be pretty broadbrush at this point.. 

While institutional details differ, the general pattern is similar.  In the immediate post-war years, with greater faith in what the state could achieve, many Western countries set up “pay as you go” pension systems, where each generation would pay the pensions (and other retirement benefits) of the one that preceded it through the tax system. A bit of nominal ring-fencing goes on, but ring-fencing like that is normally just window dressing.

There is nothing wrong in principle with a pay as you go system.  Indeed, it can be an important way to ensure that the generations alive and approaching retirement when the pension system is set up do not miss out.  However when there is a baby boom (as there was in the immediate post war years), the system can be put under a great deal of strain.  When the baby boomers reach working age, there are a lot of them to spread the burden of supporting the older generations. When they retire, there will be a lot of them who need to be supported by the subsequent generations.

But there has been another trend, which means that each retired baby boomer will be an even larger burden for subsequent generations than the pensioners they supported in their working life.  The baby boomers will live much longer, their lives being preserved by expensive medical treatments (courtesy of the tax payer again), but retire at virtually the same age. In the UK, the age at which people most commonly die has increased by 10 years for men and by 5 years for women since 1980. This means that the typical man enjoys twice as many retirement years today as the average baby boomer did. There is nothing wrong with extra longevity, but it does mean that there are more pensioners whose pensions and other benefits need to be paid for by a relatively smaller population of workers.  That means a larger burden for each worker to bear.

Most of the solutions to this problem amount to moving the stable door from wide open to ajar once the entire team of horses have got out into the wild and are well on the way to producing more horses. Broadly speaking, the plan among those countries that are planning to do anything is to slightly raise the retirement age long after the baby boomers have retired. As with any “solution” to a problem which fails to go far enough, this simply means that more drastic actions will be required later, probably just as Generation Y is nearing retirement age. That age will probably be substantially raised, and the retirement benefits they will enjoy have already been drastically reduced compared to those that will be enjoyed by the baby boomer generation.

However this offers some insight into one of the differences highlighted between generation Y and their parents. Their parents expected to work until they were 65 and then enjoy a good 20 years of retirement. In those circumstances it is rational to look for a career purely on financial criteria. Generation Y’s parents will also, for the most part, benefit from pension schemes based on their final salaries.  This dramatically increases the financial benefits of a career which sees very large salaries right at the end, because that has a huge effect on pension income.

Generation Y is probably expecting to live to about 90 and retire at 86 (yes I am exaggerating, but the point is they will work longer and enjoy fewer years of retirement). The closure of most final salary pension schemes also means that sudden salary rises at the end of their careers will not have such a dramatic effect on their lifetime incomes as it did for their parents.
All this adds up to two things:
  • Rationally the early financial rewards to their careers are more important to Generation Y than they were to their parents; and
  • Rationally their careers will be a much bigger part of their lives and so Generation Y should be looking for a career where they can follow their passion rather than one that merely provides a living.
So maybe the feelings of frustrated expectations and the desire for earlier rewards from their career, and a career that provides a lot more job satisfaction are more than simply the selfish demands of a pampered generation. They might simply be rational responses to the environment they face.