Stumbling and Mumbling

Forget the forecast figures

Danny Finkelstein says we should forget the figures on public finances. This is especially true of the forecasts for them. My table shows the recent track record for Pre-Budget forecasts of public sector net borrowing in the following year, compared to the out-turn (table PSF7 of this pdf  and the consensus forecast here (pdf) for 2007-08).
The forecast errors are large - the average, ignoring signs, is £7.6bn, or roughly 0.6% of this year's likely annual GDP. This is more than twice the shortfall which Darling alleges there to be in Osborne's tax plans.
Although these errors seem big, they are in fact smaller than previous ones - thanks in part to the macroeconomic stability Darling will tell us about this afternoon. Back in 1998, the Treasury estimated that the forecast error was equivalent to 1 per cent of GDP.
Of course, you won't hear about these forecast errors from Darling. But when he gives his new forecasts, just add the phrase "give or take £8 billion" to what he says.
This should put in context the parties' quibbles about a couple of billions here or there in their opponents' sums.

Time to abolish NICE?

Should the National Institute for Health and Clinical Excellence be abolished? The news that thousands of people could go partially blind because it has failed to approve the full use of Lucentis makes me ask.
The key line is this, from Nice's chief executive Andrew Dillon:

When treatments are very expensive, we have to use them where they give most benefit to patients.

This seems commonsensical. Where resources are limited, they have to go to their most valuable use. So, given a choice between stopping someone going partially blind and saving a life, we should choose the latter. This is reasonable and rational, isn't it?
No. The choice should not be between Lucentis and (say) life-saving cancer treatment, but between Lucentis and the lowest-valued item of general government spending.
Think of it this way. Imagine a man on a budget of £400 a week. He spends £390 a week on porcelain figurines advertised in the weekend tabloids, and £10 on food. But the £10 he spends on food is allocated so as to maximize nutritional value per penny spent.
Is this rational? Most people would say not. Although the £10 he spends on food is rationally allocated,  his overall spending is not. He's penny-wise and pound-foolish. He'd be better off cutting spending on tat.
Nice is acting like our man, who chooses rationally between beans and bananas, oblivious to the wider irrationality in spending decisions.
A rational decision-maker would not ask: should we limit spending on Lucentis  so we can increase spending on cancer treatment? He would ask: are there areas of government spending we could cut so that we could improve healthcare generally?  The answer is obvious.
What Nice is doing, therefore,  is giving a spurious appearance of rationality to what are, in fact, cruel and stupid decisions. And in doing so, it is involuntarily giving legitimacy to those decisions.

The coming public spending freeze

Government spending will have to fall in real terms for the rest of this financial year if the Chancellor's forecasts are to be met.
Today's figures (pdf) show that central government current spending on items other than interest and welfare benefits has risen by 15.1% so far this financial year.
However, in his Pre-Budget statement (B29 of this pdf) Brown forecast that it would rise only 5.3% in this financial year.
To meet this forecast, spending in December-March will have to rise just 1.1% comapred to the same period last year.
As annual inflation in the public sector is running at almost 5% (based on the general government consumption deflator in Q2), this requires a hefty cut in real terms.
Which raises the question: to what extent is Brown really in control of public spending?

Pensions bill problems

The government's plan to raise the retirement age to 68 could be both expensive and inequitable, according to a new article from the Centre for Market and Public Organization.
Sarah Smith points out that the rich live longer than the poor. Life expectancy at 65 is another 17.5 years for social class I, but only 13.4 for social class V. Raising the retirement age therefore reduces the value of a pension more for the poor than for the rich.
And uprating the pension in line with earnings rather than prices benefits the rich more, as their greater longevity means that they gain more from the power of compounding (assuming earnings rise faster than prices).
What' s more, she says, raising the retirement age might not save much money. This is because many people stop working before retirement age because of ill-health. Increasing the retirement age therefore merely means people will claim incapacity benefit for longer.
What was that Blair said?:

it is the combination of economic efficiency and social justice that marks this government out from its predecessors.

Against cutting "waste"

I fear the sainted Tim is too harsh upon Polly.
Polly says:

So what exactly would a Tory small state withdraw from? (No, "bureaucracy and waste" will not do as an answer.)

Tim replies:

Why not? Is there anyone actually insane enough to think that there is no bureaucracy or waste in our current system? Out of the 520 billion planned for spending, is there not the odd 1%, 2% or so that is currently being wasted?

Of course.  But it doesn't follow that a government should commit itself to reducing waste, because of two principles which classical liberals like Tim should recognize:
1. Limited knowledge. How can a minister spot whether a civil servant tens of rungs below him in the hierarchy is doing a good job or not? Often, he can't. To pretend you can spot waste is managerialist hubris.
2. Rent-seeking. The people charged with identifying waste - senior civil servants - are those who created it in ther first place. The people who survive a drive to cut waste will be precisely those who are good at office politics - that is, successful rent-seekers.
So, Polly's right - it's silly to promise to cut waste.
This, though, merely means Tim is even more right on the fundamental point - that if you want to cut government spending, you've got to cut government functions.

Taxes as dividends

Income tax is just like a dividend on human capital. This struck me on seeing my payslip today showing that I pay 26.9% of my income straight to the government.  So, let's push this analogy between taxes and dividends further.
1. Young firms have a lower pay-out ratio than mature ones, because they have better things to do with the money - like plough it back into the business - than mature ones.  But aren't young people similar? They invest in their human capital by though getting training and experience on the job, for which they pay by accepting lower wages.
Shouldn't young people therefore pay lower taxes? Granted, they do so to the extent that they are lower-paid than old ones. But a young person with the same pay as an old one pays the same tax, even if he's getting on-the-job experience. Is this efficient, or does it deter human capital formation?
2. Risky businesses have lower pay-out ratios than safer ones, because they need a cash balance as a cushion against profits fluctuations. Shouldn't the same be true of workers in risky occupations? Or are they fully compensated for risk through higher wages?
3. Why aren't government's income streams tradeable? They are in a sense - this is what government bonds do. But bonds don't give a right to dividend growth. Why don't  governments act like companies and securitize this growth and sell it off?  Doing so would make budget balances less vulnerable to economic downturns. Of course, there are problems writing and enforcing such contracts. But are these really insuperable?
4. Why is it only the government that has a right to dividends on my human capital? In principle, groups of workers in an occupation or industry could agree to sell shares in their human capital to others. This would. as Robert Shiller has said, help people spread occupational risk - a little like Bowie bonds. So, for example, architects could reduce the risk of a downturn in the building industry by trading shares in their human capital with doctors or software -writers, and vice versa. 
Now, I'm not saying all these ideas are feasible. I'm just asking you to think about how crude is the financing of government and human capital, relative to corporate finance.

Flat taxes: good for the poor

If my previous post was a bit harsh on the Adam Smith Institute, here's a payback - more evidence that flat taxes can be good for the poor and for the whole economy:

We quantify the aggregate, distributional and welfare consequences of two revenue neutral flat-tax reforms using a model economy that replicates the U.S. distributions of earnings, income and wealth...In both flat-tax reforms the income poor pay less income taxes and obtain sizeable welfare gains...Economic folklore has defended progressive taxation on the grounds that it is good for the poor: we find that flat taxes can be better.

There's just one problem - the more egalitarian flat-tax reform would cut output a little. But hey, there are alway trade-offs.
A reminder: Here's research (pdf) showing how a flat tax would affect the Spanish economy. Here's something I said about the link between flat taxes and equality.

Looking for a Laffer curve

Madsen Pirie says the boom in US tax revenues vindicates the idea of the Laffer curve - that cuts in tax rates can lead to higher tax revenues by boosting supply.
I fear he might be committing two fallacies here - post hoc ergo propter hoc and the confirmation bias, for three reasons.
1. As Brad DeLong points out, even Bush's own economists don't think tax cuts have paid for themselves.
2. Recent research - both macro modelling and laboratory experiments (pdf) - suggest we are to the left of the Laffer curve - tax rates generally are below the levels at which tax cuts would stimulate more effort.
3. There's an obvious other possible cause of the boom in tax receipts. It's that profits have boomed, boosting top pay and dividends. And this profit boom owes more to the consumer boom than to the supply-side effects of tax cuts.
None of this is to deny that Laffer curves exist in theory. It's trivial that they do. The place we happen to be on the curve is an empirical matter that Madsen has not illuminated.
Nor is it to deny that there might be some particular taxes where cuts might raise revenue.
Still less am I denying that there's a case for tax cuts. It's  just that the case is libertarian, not consequentialist.
Arguments for lower taxes are not helped by sloppy economics.

Stupid, and stupider

Polly Toynbee's response to George Osborne's speech merely illustrates how debased political debate has become.
First, we get Osborne utterly misunderstanding the case for tax cuts. In ruling out a promise to cut taxes he said:

That will be a disappointment to a few in my party. They think the key to winning general elections is to make up-front promises of tax cuts.

No, George. Conservatives don't want tax cuts because they're popular. They want them because they are the right thing to do. They believe the state is too big, and should be cut back. Osborne never addresses this point.
Then we get Polly's almost wilful stupidity. First, she interprets Osborne's speech in a completely opposite way to almost everyone else, so as to fit in with her pre-conceived worldview: "'Simplification' is new Tory code for cuts."
Then she utterly misunderstands the point of a flat tax, describing it as "the most regressive". This is plain false.
And then she misunderstands Tax Freedom Day:

Who exactly are the "people" who stop working for the state on June 3? Only the very, very rich, of course - the Notting Hill people. [Tax freedom day] can't be calculated exactly, since you can't apportion to individuals such things as corporation tax, nor individual VAT spending habits.

First, the Adam Smith Institute is open about the fact that the day applies to the average tax-payer, not to the rich.
Second, Polly's idea that you can't apportion VAT to individuals is true, strictly speaking, but  misleading. In table 21 of this pdf, National Statistics does apportion VAT to deciles of the population.
And it finds that the tax burden upon the rich is actually lower than that on middle incomes. In 2004-05, the fifth decile of households with children - those with average incomes of £30,052  - paid 35.8% of income in direct or indirect taxes. The top decile paid just 35.6%.
Polly's idea that the tax burden is higher on the rich than on average earners is, therefore, just false. It's a fiction designed to give the impression that Gordon Brown is an egalitarian Chancellor. He's not.
Granted, these numbers are lower than the 42.2% implied by Tax Freedom Day. But that's because the latter include taxes upon companies.
Of course, these can't be apportioned to income groups. But it's a fair bet that corporation tax reduces some combination of wages or jobs, or means higher prices. So they fall on average earners.
And finally, she boasts that tax credits have reduced child poverty at the fastest rate since records began, without asking the question: could other arrangements have done so more efficiently? She thus perpetuates the illusion that the only policy alternatives are Cameron's statism versus Brown's statism.
I don't mention all this merely to bash Polly. What's really frustrating here is that there is a political vision that both Osborne and Toynbee are oblivious to. It's a vision of a smaller state which taxes the poor less and redistributes more.

Big government? Och, noo.

Official figures released yesterday show that public spending per person in Scotland is 22.2% higher than in England, and 41% higher than in East Anglia (table 7.4 here). Scots get £8096 of identifiable public spending each (at 2004-05 prices) whilst the English get £6623.
Are the Scots healthier than the English? No. Are they safer? No. Are they better educated? Not greatly. Are they generally happier? No (pdf).
it seems there's little correlation between high public spending and better outcomes - a message corroborated by this book by Vito Tanzi and Ludger Schuknecht.
Which raises the question. Is extra public spending unproductive in Scotland? Or would the Scots be even more violent, sick and miserable without it? If so, why is there such a big difference with the English?