Paul Ryan’s 40 year detox: America can’t rely on China

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The reaction of some to the release of the Path to Prosperity budget last week by Representative Paul Ryan, Chairman of the House Budget Committee, was incandescent fury.

A New York Times editorial painted a picture of America under the Ryan budget as

“one where the rich pay less in taxes than the unfairly low rates they pay now, while programs for the poor — including Medicaid and food stamps — are slashed and thrown to the whims of individual states. Where older Americans no longer have a guarantee that Medicare will pay for their health needs. Where lack of health insurance is rampant, preschool is unaffordable, and environmental and financial regulation are severely weakened”

The Washington Post exhumed Dickens and Orwell on the way to saying

“Ryan would cut $770 billion over 10 years from Medicaid and other health programs for the poor, compared with President Obama’s budget. He takes an additional $205 billion from Medicare, $1.6 trillion from the Obama health-care legislation”

According to The New Republic the budget

“would take health insurance away from tens of millions of people, while effectively eliminating the federal government except for entitlements and defense spending”

The Huffington Post quoted one Eddie Vale, a spokesman from pressure group Protect Your Care, as saying “A Republican budget to end Medicare is a Republican budget to end Medicare, no matter what you call it”

What’s most striking about all this is what’s missing. Mr Vale and the others quoted haven’t asked themselves the crucial question about Medicare and food stamps and all the rest; will the Chinese be happy to keep paying for it all?

The United States government borrowed $4 billion today. It borrowed $4 billion yesterday and it will borrow $4 billion again tomorrow and so on. Federal government debt, which was rising by about $625 billion a year under George W Bush, is, under President Obama, rising at $1 trillion a year. According to official figures in December Federal government debt passed 100% of GDP.

In National Review Mark Steyn does an excellent job of conveying the full scale of this explosion of debt

“The 2011 budget deficit, for example, is about the size of the entire Russian economy. By 2010, the Obama administration was issuing about a hundred billion dollars of treasury bonds every month — or, to put it another way, Washington is dependent on the bond markets being willing to absorb an increase of U.S. debt equivalent to the GDP of Canada or India — every year”

And what is the Ryan budget, cause of such wailing and gnashing of teeth, proposing to do about this financial catastrophe? Under what the New York Times called “the most extreme budget plan passed by a house of Congress in modern times” Ryan doesn’t actually propose to balance the Federal budget for another 40 years.

So far America has gotten by through buying consumer goods from China and sending dollars in return. The Chinese then effectively loan these dollars back to America by buying Federal government debt, Treasury bonds. The Federal government then spends the receipts from these Treasury bond sales on Medicare and food stamps and all the rest. This is how the Federal government pays its way and it is why China is the world’s largest owner of US government debt with holdings of $1.148 trillion.

Why have the Chinese been so willing for so long to fund the consumption of Americans who’s per capita GDP is nearly six times higher than theirs?

One reason is geostrategic. America will not be able to confront the emergent power of China over Taiwan or anything else if the US government has to borrow the money from the Chinese to do so.

Another is connected to the economy and domestic politics. It has long been an article of faith among China watchers that China’s economy needed growth of 8% a year to guarantee jobs for the millions of young people entering the workforce every year, failure would lead to political unrest. If the Chinese government could only guarantee these jobs in factories producing goods for sale in the US by loaning the US the money to buy them, so be it.

Either way the entire edifice of the United States government is dependent on a line of credit from China and elsewhere. In total one third of US government debt, $5 trillion, is held overseas. With a bit of help from the Quantitative Easing of the Federal Reserve this vast market for Federal government debt has kept bond yields historically low while debt has ballooned. The Federal government is dependent upon the continuation of this line of credit for its own continuation.

But there are signs that the willingness of poor Chinese to keep lending money to rich Americans is coming to an end. Last year the previously insatiable Chinese reduced their holdings of US government debt for the first time since records began in 2001. Not only China is suffering indigestion at the amount of US government debt it is being asked to swallow. Russia and India have drastically reduced their holdings.

The reason is obvious. As a borrower, like America, piles debt upon debt it becomes ever less likely that they will be able to pay it back so you stop lending to them. Indeed, this outcome was, at some stage, inevitable.

But what of the effect on America? Like anything else as the buyers for Treasury bonds disappear their price will fall. In the world of bond financing this means higher bond yields, rising American borrowing costs in other words.

The Federal government’s debt binge will come to an end. It is simply a question, to paraphrase Von Mises, of whether this should happen sooner as the result of a voluntary abandonment of increasing indebtedness, or later amid the catastrophe of default and inflation. Maybe Ryan’s 40 year detox isn’t so bad after all?

This article originally appeared at The Commentator

Why Charlie Elphicke’s priorities are wrong

The NTE Party – Not Taxed Enough

There is a strand of thought in the Conservative party which holds that the party’s failure to win the last election was because they are insufficiently like the Liberal Democrats or Labour; respectively, a party which has popularity levels that would make Gary Glitter wince and one so bereft of ideas that the only thing they needed to worry about being stolen in a recent break in to its leader’s office was the tea bags.

It is this strain of thought which recently led Francis Maude to say that it was the Conservative party’s stance on gay marriage which would decide its electoral fortunes, a view which suggests he hasn’t spent much time canvassing lately.

It is also this strain of thought that has led Charlie Elphicke MP to write a piece for ConservativeHome titled ‘We should target overseas tax dodgers, help the low-paid and only then abolish 50p’

In a country whose government is borrowing £450 million per day, whose national debt is rising at £4,000 per second, yet which is seeing the merest trim of government spending Mr Elphicke has deduced that the problem is not that we are spending too much, but that we are not taxing enough.

At the heart of this lies what has motivated much of the opposition to the coalition’s attempts to get Britain’s ruinous borrowing under control: the idea that things can carry on as before; all we need to do is find someone else to keep paying for it.

The twist in Elphicke’s argument – what sets it a couple of millimetres apart from the sort of thing you get from any number of Dave Sparts – is that instead of targeting ‘the rich’, however defined, Elphicke has non-doms in his sights.

“We should learn from these international lessons” Elphicke thunders. Which international lessons? Well, there’s Spain with its 23 percent unemployed and the United States which, Elphicke notes approvingly, doesn’t “sit there worrying about non-domicile status. They just tax everybody, everywhere”

Well, they haven’t been taxing the increasing number of Americans who have been renouncing their citizenship rather than stump up to two countries’ governments when they only live in one. And Elphicke doesn’t address the rather obvious point that we might actually want to attract these people. He says that “This measure (taxing non-doms on their worldwide income not just that earned in the UK immediately) would raise between £500m and £1bn” annually, one or two days government borrowing in other words. But he doesn’t say whether this figure takes into account the negative effect on inward investment this would have.

As the Telegraph reported, when the £30,000 levy on non-doms which Elphicke celebrates was introduced in 2007, 16,000 of them upped sticks and left. As the Telegraph said

“The latest Treasury estimate is that 5,400 non-doms paid the levy in its first year, worth £162m in tax – way below original estimates. But how much revenue did the Treasury lose by the 16,000 non-doms leaving?

 Well, again according to Treasury estimates, non-doms pay £4bn in income tax and another £3bn in other taxes such as capital gains, VAT and stamp duty. So if 11.5pc of non-doms left in 2008-2009, as Inland Revenue figures show, then it’s not unreasonable to estimate that must equate to about £800m in lost taxes”

Can our battered finances really afford a repeat of this fiasco? They might have to. Just this last weekend the Financial Times carried a report that the number of non-doms in the UK has fallen by 16 percent since the levy was introduced. Now George Osborne is rumoured to be planning to raise it to £50,000.

If there’s no economic logic to all this neither does Elphicke even attempt to offer a moral justification. But then he appears to subscribe to the other foundational myth of the ‘anti cuts’ movement, namely that all government spending is good and, therefore, so is all tax. Tellingly, Elphicke makes no mention of spending cuts in his article.

But the truth is that there is much government spending which is a complete waste, especially following Labour’s spending spree over the last few years.

Labour more than doubled spending on education but we slumped from 7th in reading, 8th in maths and 4th in science in 2000 in the Programme for International Student Assessment rankings to 17^th, 24^th and 14^th respectively in 2008. Labour doubled spending on health but productivity, at best, only “probably improved”. It’s little wonder that people aren’t simply sitting still to be taxed to pay for all this waste.

Rather than dreaming up probably self defeating plans to find new pips to squeak Elphicke would be better off attacking this colossal misuse of taxpayers’ money. The truth is that there is much public spending which is not virtuous and, by extension, there is much taxation which is not virtuous. Some tax, quite frankly, ought to be avoided.

Elphicke is correct that moves should immediately be made to make the first £10,000 earned tax-free but this should be paid for, not with further taxes, but with genuine cuts to runaway government spending, not the glorified budgetary topiary which is the cause of so much misguided fuss.

Elphicke says that “As Conservatives we are committed to fairness and social justice”, well, who isn’t? The real question is what form you give these malleable phrases. He says “That means we believe everyone should pay a fair share” – again, who would disagree?

But it ought not to be the job of the Conservative party to define ‘fairness’ as “tax everybody, everywhere”. After all, besides wooly phrases like ‘social justice’ and ‘fairness’, the Conservatives are supposed to believe in the sovereignty of the individual and over his or her rights over their property. This is especially so when so much of this tax goes to support wasteful spending.

Leave defending that sort of nonsense to Labour and the Liberal Democrats.

This article originally appeared at The Commentator

Wake up and smell the money: the 50p tax rate doesn’t work

Cutting off your nose to spite the 1%

Wake What is the point of taxation? Is it to raise money to pay for things the government does? Or is it to wind up those in society we resent or don’t like? The answer would seem to be obvious but the current debate over the 50p tax band suggests that it is not clear cut.

The top rate of income tax was raised from 40 percent to 50 percent in 2009. With the economy tanking following the credit crunch tax revenues were vanishing revealing the extent of Gordon Brown’s uncontrolled spending. The search was on for anything which might plug the deluge of red ink.

The thinking behind it is simple. If you raise the tax on income from 40 percent to 50 percent the revenue from that tax will increase by 25 percent. But it doesn’t work like that in real life.

That people respond to incentives is one of the most basic truths in economics. If people have an incentive to do X they will do it. If they have a greater incentive to do Y they will stop doing X and do Y instead.

It is precisely this thinking that causes politicians to use taxes to incentivise/disincentivise certain desired/non desired behaviours. Home owning is incentivised and smoking and drinking are disincentivised by tax.

But when applied to labour, on which income taxes are levied, politicians abandon this logic. While they assume that raising taxes on fags and booze will lead to less smoking and drinking they think that they can raise taxes on labour without reducing the amount labouring being done.

That, it appears, has been the utterly predictable effect of the 50p tax rate.

In January the Treasury received £10.35 billion worth of income tax revenue from self assessors, generally the top rate tax payers, £509 million lower than in January 2011. Revenue from most other taxes, by contrast, went up over the same period.

This behaviour was famously modelled back in the 1970s by the economist Arthur Laffer. The Laffer Curve, like that below, says that there is a rate of tax, t*, beyond which the disincentive effect of the tax will be so great that whatever it is being taxed, be it smoking or labour, will decrease and so will tax revenue. Put simply, why would you go to work if you knew that 80 percent of your income would be taxed from you?

There are caveats. First, there is no single t* for the economy, it will vary from individual to individual and from tax to tax.

Second, it doesn’t mean, in the case of income tax, that with tax rates above t* people will simply stop working. Instead they will find ways to receive their income in forms which are less heavily taxed, the now popular bogeyman of tax avoidance. It is more accurate to say, not that labour will diminish, but that taxable labour will diminish.

The Rolling Stones did not stop recording in the 1970s when faced with tax rates of 83 percent, they simply moved to the south of France and watched on TV as Britain had to go to the IMF for a bailout. Or, like Ken Livingstone, you can stay in Britain and incorporate yourself so that you pay the Corporation Tax rate of 20 percent instead of the nearly 60 percent combined income tax and National Insurance he would have paid otherwise.

The obvious answer is a flat tax. But the same people who complain most bitterly about tax avoidanceare often most opposed to any levelling of the tax system. Those wedded to a ‘Progressive’ tax system must therefore reconcile themselves to the loopholes and avoidance that come with it.

The truth of the Laffer Curve has been seen across centuries and across cultures. The late fourteenth century Islamic polymath Ibn Khaldun wrote

“In the early stages of the state, taxes are light in their incidence, but fetch in a large revenue…As time passes and kings succeed each other, they lose their tribal habits in favour of more civilized ones. Their needs and exigencies grow…owing to the luxury in which they have been brought up. Hence they impose fresh taxes on their subjects…[and] sharply raise the rate of old taxes to increase their yield…But the effects on business of this rise in taxation make themselves felt. For business men are soon discouraged by the comparison of their profits with the burden of their taxes…Consequently production falls off, and with it the yield of taxation”

In 1933 John Maynard Keynes wrote

“Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget. For to take the opposite view today is to resemble a manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more–and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss”

When Margaret Thatcher was elected in 1979 the top rate of tax was 83 percent and the richest 1 percent of Brits paid 11 percent of all income tax. Thatcher cut the top rate of tax to 60 percent and the total amount of income tax revenue the richest 1 percent paid rose to 14 percent. When the top rate was cut again to 40 percent the share the top 1 percent paid rose again to 21 percent.

Neither theoretically nor practically can the 50p tax rate be justified on the grounds of bringing in more revenue for the government. It doesn’t.

This article originally appeared at The Commentator

Don’t worry about turning into Greece, we always have the option to turn into Zimbabwe instead

Keep the change

The British economy is walking a tightrope. On the one hand it has deficits the size of Greece; on the other it has interest rates as low as Germany.

The coalition puts this remarkable, and unsustainable, state of affairs down to its much trumpeted austerity. Investors are said to be rewarding Britain with low interest rates for acting early and decisively to curb its ruinous borrowing. The borrowing costs of Greece, Portugal, or Italy are cited as examples of the merciless knee-capping Britain could have expected without it.

With the British public and government up to their necks in debt almost all points on the political map agree that higher interest rates are an evil to be avoided at all costs. So opponents of the ‘austerity’ program have to argue that continued borrowing won’t cause interest rates to rocket. They say that we won’t incur the borrowing costs of the PIIGS because we have our own central bank and can print our own currency.

They are arguing, in other words, that we don’t need to worry about turning into Greece because we always have the option of turning ourselves into Zimbabwe instead.

It might seem eccentric to worry about inflation right now. The Bank of England has forecast that inflation will fall throughout 2012, a prediction borne out by the most recent figures. Indeed, the M4 measure of broad money has been flat.

But this isn’t because the Bank of England hasn’t done everything necessary to generate inflation. Behind these figures lies incredibly aggressive monetary ‘stimulus’. Bank of England base rates have been held at 0.5 percent for nearly three years. Quantitative easing has seen £275 billion spent since the program was launched in March 2009 with another £50 billion announced recently. The Bank of England has seen its balance sheet balloon from 5 percent of GDP to around 20 percent, an increase of 300 percent, exactly the same as its growth in the highly inflationary 1970s.

We have been saved from higher inflation so far because banks aren’t lending the money out but using it to repair balance sheets ravaged by the collapse in mortgage backed asset prices. As demonstrated by banks’ failure to meet their Project Merlin lending targets the money the Bank of England has pumped out in these various manoeuvres has been parked up on banks balance sheets.

So far so ineffective. But banks aren’t in the business of sitting atop ever higher piles of reserves and policy makers at the Treasury and Threadneedle Street speak constantly about the aim of returning to more ‘normal’ lending conditions. If banks do begin to lend and this vast pile of newly printed cash finds its way out into broader money measures then we will see inflation.

We are told that this won’t happen because when this turning point is reached the Bank of England will step in to unwind its positions. It will sell the various financial assets it has bought under QE and remove from existence the money banks use to pay for them. The inflationary money will vanish.

This obviously relies on a bit of split second timing from the Bank. It will rely on the Bank of England retiring its holdings at exactly the rate the market can absorb; hold onto them too long and inflation will result, liquidate them too quickly and interest rates will spike. Anyone who has witnessed its lead footed lumberings of recent years might wonder if it’s capable.

But could the economy withstand it anyway? When the Bank sells the assets it has bought their prices will drop and, inversely, yields and interest rates will rise; the very same interest rates which, we are told, are an evil to be avoided at all costs in a highly indebted economy such as ours. It might, in fact, be the case that the British economy is now so hooked on debt that any rise in interest rates will generate a politically intolerable level of economic pain. If this is the case then vast monetary easing will remain with us until the inevitable point at which it brings collapse.

Of course, the Bank of England might just pull it off. Even so the British economy will have another tightrope to walk.

This article originally appeared at The Commentator