IEA Blog

A single claimant of Jobseeker’s Allowance or Income Support aged 18-24 receives £51.85 a week. This goes up to £65.45 for those aged 25 and over.

Tax credit and child benefit payments for a first child are significantly higher at £75 per week, while subsequent children will earn claimant households an additional £58 per week.

It would seem to be unfair that child-related benefits are paid at a higher rate than those for young adults. In particular, young adults may have to spend around a third of their income on utility bills, whereas families will enjoy the economies of scale resulting from shared living space, meals and transport etc. Moreover, it is inconsistent that the benefits system recognises economies of scale within families (hence the first child premiums) but not in its treatment of families vis-a-vis single households.

A fairer system would standardise first child payments at the young adults’ rate of £51.85 per week, with lower payments for additional children. This could be achieved in practice by halving the child element of child tax credits. The measure would have the additional advantages of improving work incentives and cutting billions from the annual £24 billion tax credits bill.

The dismal economic returns on the Channel Tunnel Rail Link are a stark warning to supporters of a high-speed line to Scotland and the North of England.

The total cost of the link, now renamed “High Speed One” (HS1), is close to £10 billion in today’s money, when all the hidden subsidies and extras are included. And this figure does not include the substantial “deadweight” losses from the additional taxation required to fund the line. A commercial business would expect to make an annual return well above £500 million on such an investment, particularly since railways typically need to be substantially rebuilt after 30 or 40 years.

In this context, the return on HS1 is pitiful. Last year, the “investment recovery charge” levied on Eurostar was reduced by more than half to about £2,200 for each train service using the route. By my calculation, this adds up at most to about £40 million a year – a return of less than half of one per cent on the government’s original investment.

But even this return is questionable. Eurostar has made large losses during its sixteen year history and it remains to be seen whether the hidden subsidy of cut-price access charges will enable it to make sustained profits in the medium term. In other words, not just the infrastructure but the service itself has been heavily subsidised by taxpayers, meaning the overall economic return on HS1 has almost certainly been negative – even before inflation is taken into account. The local “Javelin” services to North Kent now using the line are also subsidised.

Of course, advocates of high speed lines may point to “wider benefits” such as regeneration. Indeed, the expensive re-routing of the Channel Tunnel link through East London was supposed to boost the area’s economy (as well as to facilitate currently non-existent through trains to the North of England). However, state-funded regeneration tends to be a negative sum game. Resources are inefficiently transferred from some areas to others, while social problems are displaced rather than reduced. Moreover, if nebulous “wider benefits” arguments were used consistently as a rationale for taxpayer support, just about every business activity would be entitled to subsidies and almost the entire economy would become socialised.

After sixteen years of support, the government should stop subsidising train services to the continent. Taxpayers could receive at least some compensation if the high-speed line were sold off to the highest bidder with the proceeds used for tax cuts and (unlike in current proposals for its “privatisation”) no restrictions imposed on how the route is used. Perhaps an unsubsidised international service could just about cover maintenance costs, with the sunk capital effectively written off. But far better returns could almost certainly be achieved by shutting down the line and disposing of the assets – which include substantial plots of land, tunnels under London and the Thames, and large amounts of scrap metal.

Today, the Public Sector Pensions Commission - which was established in autumn 2009 by the IEA, the Institute of Directors and other groups - has released its report, Reforming Public Sector Pensions: Solutions to a growing challenge.

A key finding is that the true value of the main unfunded public sector pension schemes is over 40 per cent of salary. However, the combined employer and employee contribution rates are set at around 20 per cent of salary – the result of the government using artificially high discount rates in its calculations.

The report calls for greater transparency on the true costs of public sector pensions and sets out a series of reform options that would bring costs down. These include:

• increasing employee contribution rates
• switching from final salary to career average earnings
• reducing accrual rates
• raising pension ages
• reducing index-linking
• ending the contracted-out status of public sector pensions
• switching to funded defined contribution arrangements

 Click here to download the report.

For perhaps only the second time in its history the IEA will feature in a comic book.

The first instance was over a decade ago when Antony Fisher, IEA founder, appeared in such a publication along with Milton Friedman. Friedman was well known and was always face on; Fisher was not well known and all one saw was the back of his head with chickens on his hat and shoulders - as he was of course the entrepreneur behind the factory farming of such birds. Very subtle stuff.

In July, Bluewater Productions, a comic book company on the west coast of the USA will launch Female Force – Margaret Thatcher, written by the IEA’s Distinguished Senior Fellow John Blundell.

This 20-page full-colour comic documents Lady Thatcher’s rise and many achievements. John comments: “I am pleased at how much scope this new medium for me has allowed for the discussion of free market economics.”

In Female Force – Margaret Thatcher, the story of the IEA’s Arthur Seldon writing to Geoffrey Howe at the end of the 1960s and asking “may we hope for better things from Margaret?” is retold. Howe’s response is also there: “I am not at all sure about Margaret. Many of her economic prejudices are sound. But she is inclined to be rather too dogmatic … there is much scope for her to be influenced between triumph and disaster.”

To purchase a copy of Female Force – Margaret Thatcher go to your local comic book store and pre-order your copy. If you are not sure where to find a comic book store then type “comic shop locator“ into a search engine.

Even Margaret Thatcher didn’t manage to dismantle Britain’s disastrous welfare system. Judging by the policy plans of the Lib-Con coalition, there is little reason to be optimistic that today’s leaders will be any more successful. The timid proposals on welfare are little more than an expansion of existing failed programmes.

It is unsurprising that welfare reform has presented such a problem for successive governments. The six million working-age adults who now receive out-of-work benefits – plus millions more over-60s receiving generous pension credits – comprise a large voting bloc. Labour would have risked losing its core support had it attacked benefit dependency.

Within the new administration, the rebranded, centrist Conservative Party will be wary of implementing policies perceived (wrongly) as an attack on the poor, while any major changes could face strong opposition from the Liberal Democrats’ hard-socialist Left.

Nevertheless, the dire state of the public finances means the Government will have little choice but to make substantial cuts in welfare expenditure…

Read the full article in The Daily Telegraph.

The Conservatives have abandoned their manifesto commitment to raise the Inheritance Tax threshold as part of the coalition deal with the Liberal Democrats. This his highly regrettable.

Inheritance Tax is clearly unjust in the sense that it represents triple taxation. Tax is paid on the initial income, then on savings and then again after death, creating significant economic distortions. One result is the small army of tax advisers employed to minimise exposure to death duties; another is that resources are allocated in order to avoid tax rather to achieve the highest returns. Perhaps most importantly, the tax reduces incentives to save rather than consume, thus lowering investment and hampering the production of wealth.

Inheritance Tax raises about £3.5 billion per annum for the Treasury – a tiny proportion of the overall tax take. The Conservative plans to raise the threshold would therefore have cost relatively little. Indeed, given its impact on investment and allocative efficiency, it is probable that inheritance tax actually reduces overall tax revenues in the long term.

The Liberal Democrats’ alternative policy of raising personal allowances to benefit the low paid is worthwhile in order to improve work incentives by reducing the horrendous marginal withdrawal rates produced by benefits and tax credits. Nevertheless, given the fiscal crisis, the measure will have to be funded by tax rises elsewhere. If, as the reversal on inheritance tax suggests, this means higher taxes for the relatively wealthy, it may represent a transfer from those with low time preferences (entrepreneurs and savers) to those with high time preferences (low-income spenders). Accordingly, the economic benefits of this realignment of the tax system are far from clear.

The impact of Inheritance Tax is explained in Euthanasia for Death Duties by Barry Bracewell-Milnes.

With the opinion polls pointing to a close result and the prospect of a hung parliament, turnout is expected to be relatively high in today’s election. Yet for economists this presents a bit of a puzzle.

Given that the chance of any single vote being decisive is so small, particularly outside a handful of highly marginal seats, the individual act of voting is arguably irrational – especially since costs are incurred, such as time and effort wasted on the trip to the polling station.

Moreover, one can only vote for a crude package of proposals, which in practice is likely to be changed significantly when it comes to implementation. The political process is extremely inefficient at responding to individual preferences compared with the fine differentiation of markets.

Worse still, various authors from the rational choice school (for example, Olson and Stigler) have shown that policy tends to be determined by special interests rather than the preferences of voters. The “logic of collective action” means that small concentrated groups have a far stronger incentive to commit resources to lobbying politicians and bureaucrats than large dispersed groups such as general taxpayers.

Special interests also engage in “agenda manipulation” to frame policy debates in particular ways and exclude perspectives that are detrimental to their cause. Indeed, Schumpeter went as far as to suggest that politicians and interest groups “are able to fashion and, within very wide limits, even to create the will of the people.” While this may be going too far, a strong case can certainly be made that such strategies further undermine the notion that voting “makes a difference.” (And in some cases, elite interests may simply ignore the wishes of voters, as with the ratification of the Lisbon Treaty).

So why do people continue to vote in large numbers? One hypothesis is that voters find it difficult to calculate probabilities and therefore don’t realise their individual vote is unlikely to make any difference. Another idea is that people vote because they value the preservation of the wider democratic process – they act out of duty and/or altruism. Neither explanation is very satisfactory from a rational choice perspective.

The heavily publicised deaths of two teenagers in Lincolnshire who took mephedrone (known as “meow meow”) has led to calls for the drug to be banned. Shadow Home Secretary Chris Grayling has stated there is a “very strong case” for banning meow meow, while Lord Mandelson has stated that its legality will be considered “very speedily, very carefully”. It would appear that little has been learnt from the failure of prohibitions imposed on other recreational drugs and that scant regard is being given to the principle of self ownership – if individuals own their bodies then they must be free to harm themselves.

There is strong evidence from previous prohibitions (heroin, cocaine, ecstasy and so on) that banning mephedrone will only increase the harm it causes. Worryingly, the “forbidden fruit effect” means that outlawing the substance may actually add to its allure for drug takers. For consumers the fact that a drug is prohibited arguably advertises its potency.

As John Meadowcroft has pointed out, prohibition “makes risky behaviour even more risky”. A ban will clearly drive meow meow further into the black economy, placing its distribution into the hands of criminal gangs. It will also criminalise otherwise law-abiding users and heighten health risks as the precise contents or quality of the drug are difficult to determine. And while meow meow is not thought to be anything like as addictive as heroin or crack, there is a danger that prohibition will push prices up and encourage users to commit crime to fund their activities. At the very least, significant law enforcement resources will be wasted on a crackdown that achieves little.

The rise in popularity of meow meow presents an opportunity for a change of direction on drugs policy. Rather than banning the substance, policymakers should remove any regulatory barriers that prevent its legal trade. In this way, the criminal element would be driven out, reputable brand names would develop and users would be confident about what they were consuming. This approach could then be rolled out to other illegal drugs such as cannabis, speed and ecstasy.

The cost of Housing Benefit (HB) has exploded over the last five years, rising from £13.5 billion in 2004/05 to £20 billion in 2009/10. This is a cause for deep concern, not just because HB is a major burden on taxpayers, but also because it produces severe disincentives for workless people to enter employment.

The benefit is withdrawn at a rate of 65p for every pound earned above a certain amount. For many claimants it is the main reason that it is not worth starting low-paid work. This withdrawal of HB is normally in addition to the withdrawal of benefits and labour market taxes that have to be borne at the margin.

The Housing Benefit trap is particularly pernicious in high rent areas such as London. The capital receives 26% of HB payments although accounting for 12% of the UK’s population. This may partly explain why parts of London have some of the highest rates of worklessness in the country despite the wide range of employment opportunities.

From time to time the newspapers print a story that illustrates the problem. Last month the Evening Standard looked at the case of a mother of six receiving HB to rent a £2 million house in St John’s Wood, at a cost of £6,400 a month. Once other benefits such as Child Tax Credits and Income Support are factored in, as well as Income Tax and National Insurance, it’s clear she would have to earn in excess of £150,000 a year to be better off in work.

Such perverse incentives, as well as the clear injustice of such cases, provide strong arguments for reform of the system both to reduce public spending and address high levels of welfare dependency.

A simple first step would be to phase in a requirement for HB claimants to pay a proportion of their rent out of their basic benefits (such as Income Support). This would act as a deterrent to those exploiting the system to live in luxury homes in exclusive areas and would encourage tenants to seek out low-cost accommodation.

A second measure would be to reform the “local connection” criteria which in effect provide claimants with an entitlement to live in a particular area, no matter how expensive. Councils should be far freer to house homeless families in low-cost areas. At the very least, they could be housed in cheaper areas within a short commute of the borough in question (for example, Westminster Council could house people in Barking and Dagenham).

The long-term solution to the Housing Benefit problem lies, however, in the liberalisation of planning and building regulations that prevent the supply of ultra-low-cost accommodation. A liberal approach to land use could finally bring an end to this costly, complex and counterproductive system, and go hand-in-hand with the abolition of housing benefit so that all welfare benefits were simply paid as untied cash.

On Friday the Office for National Statistics (ONS) released revised GDP figures for the last quarter of 2009. The BBC and other media outlets reported this as good news as Q4 growth was revised upwards from 0.1 to 0.3%. In this context, it is worth reading Edmund Conway’s article, “Don’t be fooled: GDP figures were actually revised down.”  

He points out “The size of the British economy … was actually £133m smaller in the fourth quarter than the ONS previously thought,” and goes on to quote Andrew Lilico: “The faster growth … was entirely the result of a downwards revision to 2009 Q3.” Conway also notes with concern that the ONS press release on the revisions is entitled “Services growth in December pushes up GDP estimate.”

In other words, GDP is smaller today than people thought before the revision. The only reason why growth is higher is because three months ago the over-estimate was even greater. One of the authors once read a spoof on Conservative employment figures in 1981 that read: “Though unemployment has risen again, the government is delighted that there has been a slowdown in the rate at which the increase is rising. It is also delighted that, for the fourth month running, the number of unemployed is less than the population of Norway.” But the ONS and the BBC are not the government. The government can spin the figures how they like. However, it is not the job of supposedly independent organisations to (in the case of the ONS) create the spin and (in the case of the BBC) reflect the spin. The headlines should have been “National income revised down” with a possible sub-headline: “Stronger rebound from lower level.”