It’s not just the economy, stupid.
It’s everything, stupid.

Via Business Minister Mark Prisk wants to strip away the red tape – Telegraph:

Friedrich von Hayek is a controversial choice as a pin-up. But a signed pamphlet that the Austrian-born economist wrote in 1980 entitled “Full employment at any price” is proudly framed on Business Minister Mark Prisk’s wall. In placing it there, the Conservative MP for Hertford and Stortford is following in a line of leading Tories to place their faith in one of the 20th century’s most prominent economic theorists.

Great news, but let’s hope my colleagues are reading Hayek’s much-neglected Prices and Production, which explains the structure of capital and which allows a better grasp of real patterns of economic activity.

Hayek is useful, but I find his work takes for granted Mises, who wrote “Society is cooperation; it is community in action.” Consequently, Hayek can be misunderstood. Mises’ work has as a primary theme “social cooperation”: his theories explain the realities of acting individuals working together to improve their condition, that is, the cooperative relationships which constitute civilized society.

Meanwhile, I am beginning Mises’ Omnipotent Government – The Rise of the Total State and Total War (1944), which can be read online here. Read more

Concerned constituents — including basic rate taxpayers, pensioners and private residential landlords — have written to me about the Government’s proposed changes to Capital Gains Tax (CGT). In this post, I will set out details of the tax, the proposal, the arguments and my position.

I conclude that the way to raise CGT revenues is to reduce the rate, ideally to under 10%.

CGT and the proposals

Via HMRC, “Capital Gains Tax is a tax on the profit or gain you make when you sell or ‘dispose of’ an asset.”  Presently, there is an Annual Exempt Amount of £10,100 for each individual and £5,050 for most trustees. One pays tax on the excess over that amount at a flat rate of 18%.

There are a number of reliefs, including, for example, Entrepreneur’s Relief:

If you qualify for Entrepreneurs’ Relief, the amount of qualifying gains liable to Capital Gains Tax is reduced by four-ninths, resulting in an effective rate of 10 per cent on all qualifying gains up to £1 million. Claims can be made on more than one occasion up to a £1 million lifetime limit.

The Coalition Agreement says (emphasis mine):

We will increase the personal allowance for income tax to help lower and middle income earners. We will announce in the first Budget a substantial increase in the personal allowance from April 2011, with the benefits focused on those with lower and middle incomes. This will be funded with the money that would have been used to pay for the increase in employee National Insurance thresholds proposed by the Conservative Party, as well as revenues from increases in Capital Gains Tax rates for non-business assets as described below. The increase in employer National Insurance thresholds proposed by the Conservatives will go ahead in order to stop the planned jobs tax.

and

We will seek ways of taxing non-business capital gains at rates similar or close to those applied to income, with generous exemptions for entrepreneurial business activities.

That is, the Coalition plans to transfer wealth from those making non-business capital gains to those on low and middle incomes.

The arguments

At The Telegraph, Ian Cowie says:

Investors with substantial portfolios of property and/or shares who have not protected them in tax shelters – such as trusts, individual savings accounts (ISAs) or pensions – face the daunting possibility that HM Revenue (HMRC) may grab half their gains.

This could destroy many people’s plans to use buy-to-let portfolios or shares accumulated over long periods of time to fund retirement.

At ConservativeHome, Philip Booth, Editorial and Programme Director of the Institute of Economic Affairs, argues that the Conservatives have made a big mistake in accepting Lib Dem proposals for Capital Gains Tax. He says that CGT is seriously misconceived, that it raises little revenue and that it can do much economic harm.

In particular, Booth argues that CGT is a double tax:

But the really pernicious aspect of CGT is that it is generally a double tax. We think of capital gains enriching somebody as if they arise like manna from heaven – and therefore are worthy of being taxed. But investments are valued for the income they produce. The values of investments fluctuate up and down, but investments only go up in value in a sustained way when investors expect them to be more profitable in the long term. Those profits, of course, will be taxed when they are earned.

Furthermore:

It is beginning to dawn on people that one of the reasons for the financial crash was the foolish over-taxation of equity finance that exists in nearly every developed country. It gives incentives to companies to load themselves with debt and create complex financial engineering instruments. It may not have been the main cause of the crash but the instinctive dislike that governments have for “profits” and the way they treat profits in the tax system needs to be reformed. The coalition wishes to move in the opposite direction.

He concludes:

As it is, this proposal to increase capital gains tax is deeply flawed. It is a kick in the teeth for savers; it is a kick in the teeth for those who cannot afford to avoid it; and it is a kick in the teeth for companies that do not load themselves with debt. The effects on the private rented market could be most regrettable. Why anybody should want to bias the tax system further in favour of debt financing in the wake of the financial crash is a mystery to me and why anybody should want to tax savings and investment yet further, as we recover from the lowest savings ratio in history, is completely baffling.

The Adam Smith Institute, has produced a report, which (emphasis mine):

reviews international evidence on the effect of capital gains tax rises on government revenues, finding that tax rises tend to decrease revenues while tax cuts tend to increase them. It suggests that aligning CGT rates with income tax, as the UK government has proposed, would significantly hit revenues and worsen the deficit, as well as discouraging much needed investment. It also refutes the idea that CGT is primarily a tax on the rich, suggesting instead that CGT hikes will hit ordinary families and – in particular – retirees. Finally, the report describes the idea that people can easily shift income to capital gains and thus avoid taxes as a theory in search of some evidence, pointing to numerous countries with high income taxes and low capital gains taxes where this does not seem to be problem.

The report includes an illuminating chart which shows that, in the United States, “every time the capital gains tax has been cut, capital gains tax revenues have risen. Every time the capital gains tax has been raised, capital gains tax revenues have fallen.”

Capital gains realisations and tax rates

The revenue-maximising rate discovered by a study reported in that paper was 9.69%.

The Adam Smith Institute paper concludes:

What then is the correct policy response at the current time? It is clear that the proposal to align Capital Gains Tax with income tax rates, increasing it from 18 percent up to 20, 40 0r 50 percent is inappropriate. It fails to distinguish as it should between short-term speculative gains and long-term asset appreciation. There should be such a distinction, as there is in the US, where gains realized within a year are taxed as income, and longer-term gains are taxed for most people at 15 percent.

The UK could respond similarly, taxing one-year gains at income tax rates, but keeping the 18 percent rate for longer-term appreciation. If the aim were to maximize revenue, that might be achieved by cutting the 18 percent rate to 10 percent. For maximum economic benefit a taper could be introduced to phase it out to zero for assets held for 5 years or more. Either of these policies would be far less damaging than the current proposal.

In his diary, John Redwood MP argues similarly. After suggesting that gains in under one year should be taxed as income, he writes:

I therefore suggest that longer term gains should be taxed at lower rates. If you taxed 2 year gains at 30% and three year gains at 20%, higher rates than the current one, you could tax gains of four years or more at 10%. This should increase the total revenues from CGT by the second year, and offer a stimulus to longer term investment. I would myself go further and offer no capital gains after five years, to send a strong signal to the world’s investors that the UK is back in business as a favourable location.

I have been swamped with support for these suggestions, both from around the country and from Conservative MPs. It would send a strange signal if a Lib/Con government decided to more than double the CGT rate set by a Labour government. It would damage the revenues and be unfair to anyone who saves, is prudent, or who ventures their money for the greater good.

My position

Increasing the tax free allowance for low and middle income earners is an entirely laudable aspiration. I would go further than the LibDem proposal of a £10,000 allowance. It should be possible to buy a modest home, raise a small family and provide comprehensively for their needs without paying income tax at all. The threshold necessary to realise that aspiration is, of course, unrealistic today.

So, how to pay for increases in the income tax allowance? Increases in the rate of CGT can be expected to reduce CGT revenues. CGT is a voluntary tax: it can be avoided by retaining assets. Moreover, something called the Laffer Curve means that beyond a certain point for every tax, increasing its rate reduces revenue because people adjust their behaviour.

Increasing CGT rates would not pay for an increase in income tax allowances: quite the reverse.

If we wish to maximise CGT revenues, then we should learn from the United States’ experience and lower CGT to around 10%, tapering it out altogether for assets held for over five years.

The Coalition Government plans “generous exemptions for entrepreneurial business activities”, but entrepreneurship is the act of bearing uncertainty, so all investment in capital to fund future expenditure is entrepreneurial. Any increase in Capital Gains Tax is a discouragement to entrepreneurship and self-reliance.

There are also arguments to be made about the injustice of sudden changes in taxation and the manner in which they are implemented, but that is a task for another day.

In summary, I am opposed to raising Capital Gains Tax rates because:

• It would reduce CGT revenues.
• It would hit ordinary families and retirees.
• It would discourage self-reliance and personal entrepreneurship.
• It would encourage employment, not entrepreneurship, which we desperately need.
• It would discourage capital formation, which is the essence of rising living standards for ordinary workers.

In a rational world of moderate government spending, we would simplify all taxes and level income tax down towards a new, lower rate of CGT while increasing tax free allowances.

Labour, tragically, has ruled out that option.

See also

My review of Roger Koppl’s Big Players and the Economic Theory of Expectations:

Big Players are privileged actors who disrupt markets. A Big Player has three defining characteristics. He is big in the sense that his actions influence the market under study. He is insensitive to the discipline of profit and loss. He is arbitrary in the sense that his actions depend on discretion rather than any set of rules. Big Players have power and use it.

This post originally appeared at cobdencentre.org.

Via FT.com, Ofgem urges a shake-up of the energy market,

Sweeping reforms of the UK’s energy market must be brought in urgently to protect energy supplies, reduce greenhouse gas emissions and deliver the £200bn investment needed in the power sector, the energy regulator said on Wednesday.

Ofgem said options for reform would include placing more stringent legal obligations on energy suppliers, and “improved market signals”, which could include a higher price on carbon dioxide emissions. More drastic options could include a centralised renewables market and a central buyer of energy for the whole of the UK.

Which all seems very well, until you realise that this is the fruit of an ideological aversion to the free mutual cooperation of individuals and corporations. Ofgem apparently tell us, “It would mean taking away the market’s role in delivering that investment.”

We need to make our minds up about whether planned or free economies can provide us with the means of our survival and prosperity. History’s answer is clear: planned economies cause misery and then collapse.

Further reading

• Living with Leviathan, David B Smith
• Moral Markets and Honest Money
• Ofwat, Water UK, the Consumer Council for Water and The Managerial Revolution (via stevebaker.info)
• XXXVI. THE CRISIS OF INTERVENTIONISM: The Harvest of Interventionism (via mises.org)

Via The Telegraph:

David Cameron, the Conservative leader, has pleaded with his MPs and voters to allow him to concentrate on fixing the fragile British economy if he becomes Prime Minister rather than having “a massive Euro bust up” over the Lisbon Treaty.

Many of us with an international perspective on human cooperation have strong, principled objections to a government that cannot be dismissed at the ballot box. However, David Cameron is right: the clear and present threat to the livelihoods of British people is the state of the economy, not the EU. And George Osborne is right: we need an economy based on save and invest.

Consider the analysis provided by my Cobden Centre colleague, Ewen Stewart:

Equity Strategist Ewen Stewart makes the case that the national debt will within 5 years be over £150,000 per family of 4 with debt repayments of twice the present defence budget, up from £31 billion in 2008/9 to £70 billion in 2013/14. He explains the root causes of our difficulties and indicates a route to recovery.

It’s all over. What a fuss about nothing. The economy will soon be growing again and, look, the FTSE100 is up almost 50% since the March low. Even house prices, according to the Halifax, have risen 6 months in a row. The doom mongers were wrong. Central Banks and Keynesian public spending programmes, together with QE, have worked. Brown indeed has saved the world!

Well that would be one interpretation and a very short sighted one too, for this recovery shows all the hallmarks of a drug addict who claims to be going straight injecting a further mighty dose of the substance that has caused such decay in the first place to prolong the party.

The problem is that the underlying fault lines in the UK economy remain and, thanks to the Government’s response, are even more pronounced.

I thoroughly recommend the entire article: Happy days are here again? Another view from the City » The Cobden Centre.

We simply cannot allow ourselves to slip and let Labour retain power. Everyday British people cannot afford a hung Parliament. We must win strongly and deal with the most urgent and important problem before us: a wrecked economy.

We cannot escape our fate by sticking with Labour’s insensible reactionary fear. We must think.

We cannot keep creating new money: it would eventually destroy the economy completely¹:

Continuously injecting additional amounts of money where it creates temporary demand, together with an expectation of continuously rising prices, draws labour and resources into use in areas which will last only as long as the supply of new money. These policies bring about not so much a raise in the level of employment, but a distribution of employment which cannot last and which eventually can only be maintained by ruinous levels of inflation.

We cannot keep borrowing from future generations: it is just plain wrong and the markets would stop us.

We cannot grow a healthy society by simply seizing the wealth of one and giving it to another. Try doing that with your children’s sweets: you will get little more than screaming, sobbing and tearful mumbling. It is a dead end.

Ewen’s article sets out his policy prescriptions. The way out is the grown-up way: working, saving and investing.

So here is the greatest danger this country faces: a Labour government of childish fantasists who know nothing about creating real prosperity and everything about appearing strong before the camera. They are failing us all: it is tragic.

As my friend Chris Neal — a man with a big heart for the poor and CEO of charity GB Job Clubs — has written of Labour, bringing Cromwell up to date:

It is high time for me to put an end to your sitting in this place, which you have dishonoured by your contempt of our democracy, and defiled by your practice of top down government; ye are a factious crew, and enemies to all good government; ye are a pack of mercenary wretches, and would like Esau sell your country to the Brussels federalists for a mess of pottage and a title; and like a Judas betray your Queen and country for a few pieces of money; is there a single virtue now remaining amongst you?

Is there one vice you do not possess? Ye have no more sense of democracy than my horse; you have sold our Gold; which of you have not barter’d your conscience for the whips? Is there a man amongst you that has the least care for the good of the Commonwealth? Ye sordid prostitutes have you not defil’d this sacred place, and turn’d Parliament into a den of impotent lickspittles, by your immoral principles and wicked practices?

Ye are grown intolerably odious to the whole nation; you were deputed here by the people to get grievances redress’d, are yourselves become the greatest grievance. Your country therefore calls upon me to cleanse this Augean stable, by putting a final period to your iniquitous proceedings in this House; and which by God’s help, and the strength he has given me, I am now come to do; I command ye therefore, upon the peril of your lives, to depart immediately out of this place; go, get you out! Make haste!

Ye venal slaves be gone, not to Brussels by Eurostar but to your shires to beg the forgiveness of the people you purport to represent! So! Take away that shining bauble there, and lock up the doors. In the name of God, go!

Further Reading

• Moral Markets and Honest Money
• Prices and Production
• Huerta de Soto, Jesús: “Money, Bank Credit and Economic Cycles”

1. See The pretence of knowledge which explains how economists come to make astrologers look good. [↩]

With Dr Tim Evans joining the Cobden Centre as Chief Executive and after the publication of a number of substantial new Insight articles, it has been quite a week for The Cobden Centre.

Today, Toby Baxendale has published a refutation of the mechanistic Quantity Theory of Money, the theory on which QE is based:

The mainstream economists hold that the volume of money in circulation, times its velocity is equal to the prices of all goods and services added up. This is the famous Theory of Exchange, MV=PT, or the mechanistic Quantity Theory of Money, where:

• M is the stock of money,
• V is the velocity of circulation: the number of times the monetary unit changes hands in a certain time period,
• P is the general price level,
• and T is the “aggregate” of all quantities of goods and services exchanged in the period.

It is held by the overwhelming majority of all economists, that if the velocity of money falls, the price level will fall and thus it is the duty of government, the monopoly issuer of money, the chief Central Planner of the Money Supply, to create more money to keep the price level where it is and thus preserve the existing spending habits of the nation.

In a nutshell:

• The monetary authorities do not have an adequate measure of the money supply.
• The velocity of circulation makes no economic sense.
• The general price level aggregates away a vital factor: the relative structure of prices.
• The aggregate quantity of goods and services sold is an impossible sum.
• The mechanistic Quantity Theory of Money is not a causal relation but a tautology.

Please see the main article for details. I have commented extensively there.

In a move to expose just how much money ends up in the government’s coffers, London hairdresser Michael Van Clarke has started issuing all customers with a full tax receipt – and he’s urging other retailers and businesses to follow suit.

…

“Effectively, for every £4 we work hard to earn, we’re rewarded with £1 spending power. The rest goes to our shamed government. It’s a scandalous situation, and we hope our full tax receipts will go some way to highlighting the state of affairs!”

via Real Business – Michael Van Clarke’s crusade against hair-raising taxes.

Drawing on the work of Nobel Laureates in economics from three traditions, plus numerous other distinguished scholars, Cobden Centre Chairman, economist and successful entrepreneur Toby Baxendale presents an informal introduction to our proposal for honest money and the benefits consequent on the reform. See also our precis of Irving Fisher’s 100% Money.

via A day of reckoning: how to end the banking crisis now » The Cobden Centre.

Via The Cobden Centre » Honest money, a summary of economist Irving Fisher’s “100% Money”:

The 100% proposal is the opposite of radical. What it asks, in principle, is a return from the present extraordinary and ruinous system of lending the same money 8 or 10 times over, to the conservative safety-deposit system of the old goldsmiths, before they began lending out improperly what was entrusted to them for safekeeping. It was this abuse of trust which, after being accepted as standard practice, evolved into modern deposit banking.

Via Skype under threat from eBay licence row | Technology | The Guardian :

The internet auction company paid a total of $3.1bn for the telephone service between 2005 and 2007 and is now locked in a legal battle with the technology’s owner, Joltid, a company owned by Skype’s founders. That may make it impossible for eBay to follow its plan to float Skype on the stock market next year – and give one of Skype’s creators, Niklas Zennström, the upper hand in any negotiations. Zennström has been angling to buy the company back.

In other words, eBay bought the company at great expense, but not the critical technology that makes it possible.

At least no one is asking for a bail-out…

Via FT.com / Companies / Financial Services – Nomura has Lehman’s old crown in sight:

Ten months ago when Lehman Brothers collapsed, it would have been a stretch to suggest that the former investment bank might reclaim its crown as the biggest broker on the London Stock Exchange.

But on Monday the new owner of its European equities trading business, Nomura of Japan, said its newly constituted European equities arm was now the LSE’s third-largest broker, behind Credit Suisse and top-ranked Merrill Lynch.