Saturday, 15 August 2015

The Tax Burden

Austerity spending cuts are driven more by the current government's ideological commitment to reducing the tax burden than their desire to reduce the deficit.

This graph uses Eurostat data to show how the tax burden/GDP has changed (and is forecast to change) for a range of countries.

The UK is the only one of these countries to have materially reduced its tax burden over this austerity period.

Now let's look at indexed real total government spending over the same period

The relative severity of the UK's spending cuts is clear - only the extreme cases of Ireland and Greece (and to a lesser extent Spain) have suffered more.

I've kept the index scales the same so we can visually appreciate the difference between these two trend lines. If there was no GDP growth the sum of these two lines would roughly1 show us the trend in deficit. Of course in reality GDP growth acts as a multiplier to dampen (or potentially reverse) the trends we see in the first graph, so a key judgement call is whether the reduction in tax burden drives GDP growth more than the associated reduction in expenditure slows it.

So let's look at the net outcome of all of this in terms of deficit/GDP;

I would tentatively suggest that those countries which have been willing to use taxation to fuel spending (or at least haven't reduced spending to enable tax cuts) are currently seeing a better net outcome in terms of deficit reduction.

The core "anti-austerity" argument is that government spending is a key driver of economic growth, so to cut spending during an economic slow-down (and particularly when interest rates are close to zero) is damaging to the economy. It strikes me that if you look at the data it shows that the main driver of reduced spending in the UK is the obsession with reducing the tax burden. I wish more politicians had the courage to address that issue head-on.

Now of course if you're ideologically committed to reducing taxes you might argue that this is all well and good. Nobody wants to pay more tax in the same way that nobody wants austerity - and there are plenty who believe we should live in a lower tax / lower spend economy. I don't share that view, but I can understand it.

But even those who believe that a government's primary objective should be to reduce the tax burden (as opposed to, say, caring for the least well-off in society) must surely question the timing. Should we be reducing taxes and therefore reducing spending at a time when most would agree that the economy would benefit from increased government spending "if we could afford it"?

I've commented before that CEOs - who should be focused on long-term shareholder value - are actually incentivised to maximise "CEO lifetime remuneration value". I suspect most chancellors are in a similar situation; they are incentivised to make policy decisions which improve their chances of short-term political success rather than serving the long-term interests of the economy. Cutting taxes is awfully popular - as long as voters don't draw the connection between this and the hardship caused by "austerity".

A confession: the more astute among you may be asking why these graphs start in 2008 and why I've used indexed data in two cases. The answer is simple - it serves my argument best to present the data that way. It's all true, but unlike my previous post (> Who's Really Against Austerity) I have presented the data here in a way to help me make a (valid) point. I recommend you read that previous post if you want to see a less agenda driven presentation of the figures (and see some very interesting and informative comments posted in response )

1. Tax burden represents c.90% of the UK's total revenues and the only cost excluded from the expenditure graph is debt interest

Sunday, 9 August 2015

Who's Really Against Austerity?

It's increasingly clear that the key to political popularity these days is to tell anybody who'll listen that you're "anti-austerity" and that your opponents are "pro-austerity". It's quite simple really: we're being subjected to unnecessary hardship because [insert nemesis] is ideologically committed to austerity and causing unnecessary economic pain. The names of Paul Krugman and Joseph Stiglitz are normally mentioned; cue rapturous applause and soaring poll ratings.

Now the two Nobel Laureats cited above are undoubtedly hugely influential economic thinkers and staggeringly smart men - but I would suggest they are only peerless in their field when it comes to self-promotion. You don't need to believe you're smarter than them to observe that it's easy to build a popular following by telling people that they needn't be enduring the austerity being foisted on them by nasty politicians. That those nasty politicians have to prioritise actually running national economies ahead of selling popular books on economics and building their media profiles is by the by.

I'm not saying that Krugman and Stiglitz are wrong - I'm simply suggesting that they could well be wrong, that having a Nobel Prize does not confer infallibility.

If we were able to sit and discuss the question of austerity with either of these two eminent men, I'd like to think that they'd make nuanced arguments. Maybe they'd suggest that austerity isn't really a binary choice - it's not something that you either do or don't do - but that's its all about timing and degree. Maybe they'd sheepishly explain that part of their role is to gain headlines, fill column inches, boost their universities' profiles - to be box office.  Maybe we'd discover some of their more simplistic (some say strident, some say patronising) pronouncements are simply a result of them playing to the gallery;
"I don’t know how many Britons realise the extent to which their economic debate has diverged from the rest of the western world – the extent to which the UK seems stuck on obsessions that have been mainly laughed out of the discourse elsewhere" - Paul Krugman
"Austerity has failed. But its defenders are willing to claim victory on the basis of the weakest possible evidence: the economy is no longer collapsing, so austerity must be working!" - Joseph Stiglitz
When it comes to the public debate they are in the enviable position of arguing against strategies currently being pursued - it's pretty easy for them to simply assert that whatever the current outcomes, it would have all been so much better if only more politicians had listened to them.

Unfortunately for Krugman he squandered some of this advantage by making doom-laden forecasts of continued economic decline and spiraling unemployment. As many commentators have pointed out, events have proved him wrong: "Paul Krugman is wrong about the UK and borrowing" (Andrew Lilico), "Where Krugman Goes Wrong About Expansionary Austerity" (Tim Worstall), "Paul Krugman has got it wrong on austerity" (Jeffrey Sach).

Fair enough. There's nothing wrong with lauded experts' forecasts occasionally being seen to be wrong (unless you're one of those who believe Nobel Prize winning economists are somehow meant to be infallible).

How does Krugman explain why economies pursuing the austerity he dismisses have been recovering? Take this example where he states that after imposing "harsh austerity" in 2010:
"... Prime Minister David Cameron’s government backed off, putting plans for further austerity on hold (but without admitting that it was doing any such thing)" - Krugman
Krugman is so passionately wedded to "austerity bad" (in a way that doesn't allow for any nuance around nature or degree of austerity being pursued) that the only way he can explain how unemployment has continued to fall and modest economic growth has been delivered is to suggest that we've not really been experiencing austerity after all. We went from "harsh austerity" (we'll come on to look at whether that was actually true) to no austerity at all. Who knew?

Of course the reality that Krugman himself is tacitly admitting to here is that austerity isn't as black-and-white a choice as his headline assertions would have us believe.

One of the problems is that it's not always clear what we mean when we talk about austerity. This isn't "just semantics" - it's important that we agree what a word means before we decide if we're for or against it.  Let's take two definitions of "austerity";
  • "In economics, austerity is a set of policies with the aim of reducing government budget deficits. Austerity policies may include spending cuts, tax increases, or a mixture of both."
    - Wikipedia
  • "A lower standard of living associated with the curtailment of government spending" - Chambers Dictionary: 
Of course the first of these defines austerity policies, the second describes the hardship that is one of the potential outcomes of some austerity policies. This semantic confusion is easily exploited in the world of sound-bite politics. It's as if we used the same word for surgery and pain: we're probably all against pain (other than the occasional masochist among us) but I'd suggest fewer of us are against surgery.

So let's agree that by "anti-austerity" we mean being against directly addressing the deficit through spending reductions and/or increases in taxation rates (the alternative being to increase expenditure and/or lower taxation rates in the hope that resultant economic growth will lead to higher tax revenues sufficient to cause indirect deficit reduction ... or I suppose if you're really blasé there's an option not to worry about deficit reduction at all).

If you accept this definition and think about it for even just a nano-second, it's clear that statements like "Anyone who understands macroeconomics knows that austerity is microeconomic theory that can't work" are nonsensical. The corollary of that argument would be that no spending level can be too high, no taxation level can ever be too low - that no matter what the deficit level you should never reduce spending levels or raise tax rates (because that would be the very definition of austerity and that "can't work").

As an aside; the quote above comes from a Twitter exchange with Richard Murphy of Tax Research UK. He often makes very useful contributions to taxation debates in particular - but in this instance he actually asserted that austerity was "deliberate sabotage of UK economy". He appears to be currently acting as Jeremy Corbyn's economic advisor. Quite incredible.

To be clear: I'm not championing "austerity" here, I'm merely suggesting that we have to look at the nature, scale and pace of austerity measures being introduced before we can form a view as to whether they are appropriate or not. I'm also not arguing that the way the austerity we have experienced in the UK has been delivered is "right" - I happen to believe that too much attention has been paid to reducing spend and not enough to raising taxes (as we'll come on to see), and that the spread of pain has fallen far too heavily on the poorest in society. This graph (created by the ever excellent IFS) illustrates the second of these points clearly - the people being squeezed down on are not the middle, they're the poor.

Twitter exchanges have taught me that people struggle to read this graph  so I'll walk through it (assuming you've at least read the title). 
  • From left to right we see the poorest in society across to the richest, broken into deciles (groups of 10%) - so the poorest 10% in our society are the left-most column, the richest 10% the right-most of the continuous sequence. The final column on its own on the right is the overall average.
  • The coloured bar elements sum to show the annual cash impact (the white line) of the tax and benefit reforms on individuals in each of these groups - so the poorest 10% loose £800, the next poorest 10% lose £1,300 ... whereas the richest 10% only lose £200 and the second-richest 10% actually gain nearly £200
  • The blue line shows the same thing but as a percent of net income (i.e. what proportion of "take-home" money is lost) using the right-hand scale  - so the poorest 10% and next poorest 10% are about 7% worse off ... whereas the richest 10% are only 1% worse off and the second richest 10% are actually slightly better off.


It strikes me the only way we can move away from the simplistic binary rhetoric of pro- and anti- austerity is to look at some actual data - what levels of austerity are we in the UK experiencing and how do these compare with other economic areas? If we're "anti-austerity" what precisely is it that we're against?

I've downloaded info from the Eurostat Annual Macro-economic Database (May 2015) and stuck to this single source (trusting that the EU's economists are better at compiling cross-country comparable economic data than this weary blogger). The data series they provide includes forecasts for 2015 and 2016 - for some reason they don't provide data prior to 2006 for "Euro area" or Greece. So be it.

The analytical approach I've chosen is to take 2006 as a base year for indexing purposes  (i.e. the year before the current economic crisis kicked-off) and to look 10 years either-side so we can see the net effect of the financial crisis and austerity measures in context. It's an approach that has its pros and cons (choosing an arbitrary starting year is always slightly dodgy) but it gets us going, allows us to at least start asking some sensible questions.  If you think of understanding the figures as peeling the onion, what follows is just the removal of the crusty brown outer layer.

Starting with government expenditure (excluding debt interest) in real terms and comparing the UK with the US and the Euro Area;

The surge in spending through 2007 - 2012 is due in part to government interventions to support the banks1 (the UK intervened earlier than the Euro Area) ... so presumably part of the subsequent apparent decrease would be due to these interventions not being repeated. The key here is that I think it's reasonable to compare our 100 index point of 2006 (before any interventions) to 2014 (after the main interventions) to get a sense of the underlying real terms increase in spending over that period. On that basis we can see that government spending in the UK and Euro Area is actually about 10% higher than pre-crisis levels and the US is on track to be 20% higher. 

Now let's add to this graph some selected Euro Area countries to provide a little wider context - the scale of the financial intervention in Ireland of course stands out;

It's interesting to note that the only countries spending below pre-crisis levels are (of course) Greece and (just) Italy. The trend in UK spending is towards the bottom end of the range of other countries but is very similar (post 2006) to Germany and the Euro Area countries. Prior to 2006 it's clear the the UK's rate of government spending was increasing at a markedly faster rate than all but Ireland; France and in particular Germany have seen far smoother (but on average lower) spending growth over the period. The forecasts (when Eurostat published these figures in March) are for The UK to be the only country other than Greece to be reducing real spend.

As an aside: in the context of the Scottish FFA debate I've highlighted before that if you were to close the £8bn deficit gap through spending cuts that would require a 12% reduction in government spending. That would drop us somewhere between Italy and Greece on this graph - proof that it could be done I guess.

To what extent are these absolute expenditure trends supported by GDP growth? To understand this (and get a sense of the different government spending models) we can look at spending as percent of GDP;

It's no surprise that the US has a lower government spending model and it's clear their forecast spending increase is GDP growth driven (spend/GDP is actually slightly declining). The UK's model is to to spend slightly less of GDP than the Euro Area average - and the current trend is to further widen that gap.

Adding other countries for a wider perspective, France's higher spend model stands out.

So we've seen the spend side of austerity - now let's look at the taxation side. We're going to look here at the Tax Burden as percentage of GDP2 so we can see the extent to which tax has been used as austerity measure (again indexed to 2006);

It's striking that (relative to the starting point of 2006), the UK has been been reducing the tax burden overall whereas the Euro Area and the US have been increasing it. Oil revenue declines will be a contributing factor here but certainly doesn't explain this size of shift3; clearly something else is going on. Depending on your perspective you might see this as justified if it drives superior growth in the UK, or you might feel that increasing the overall tax burden is (potentially) a good way to make sure those with broader shoulders can take their share of the pain of austerity (and free economic capacity for spending driven growth).

Adding other countries to the graph simply reinforces this observation - the UK's is the only line heading downwards in recent years, the only country reducing our tax burden;

Here's a good point to pause and consider Krugman's comment about the "harsh austerity" implemented in the UK in 2010.

I'd suggest you would measure "harshness" by either the steepness of either the increase in tax burden/GDP or the decrease in real expenditure - or possibly by the overall change in these measure from 2006 (pre-crisis) to now. On that basis I reckon Greece, Ireland and Spain have experienced far harsher cost side austerity than us and we've largely avoided tax side austerity (unlike Greece, Italy, France and - to a minor degree - Germany).

Some of the poorest people in the UK have experienced austerity of course (per the earlier IFS "squeezed Poor" analysis) - but at a macro level it's hard to argue that the UK as a whole has experienced "harsh" austerity.

To complete the picture it makes sense to look at the tax burden as a percentage of GDP. As you would expect this is broadly the same profile as the spend/GDP graphs: the US economy is a low tax / low spend model; the Euro Area is (on average) a higher tax / higher spend model than the UK

You know the drill by now - we'll add other countries and you can pick your favourite;

So now we've got an actual data driven view of the alternative tax/spend and austerity models being pursued, let's see what macro outcomes are being delivered. We'll start with real GDP (again indexed to 2006);

The Euro Area has had it's double dip recession and is limping back towards growth; the UK is back to reasonable levels of growth; the US has been growing steadily now for 5 years. If what we've been experiencing is austerity, by this measure at least it's working. Of course we will never know what might have happened had we just kept spending ...

Let's add the other countries for the wider context;

It's clear that in terms of real GDP growth only the US and Germany (of our selected subset of countries) have done better than the UK since 2006 ... and if you look carefully you'll see that we've grown faster than all of these comparators except the US since 1996*. The scale of Greece, Italy and Spain's woes is clear, as is the extent to which they drag down the Euro Area.

*Addendum: looking again I see Ireland has actually grown significantly faster over the long period

Finally let's look at Deficit/GDP. This is simply an arithmetic function of all the figures we've just covered plus non tax-burden government revenues less debt interest4,5 (I'm too tired to graph these but trust me it all adds up - I'm careful like that);

On this important measure (below the line means the absolute debt is increasing), the UK and the US started from worse positions in 2006 and fell deeper than the Euro Area - but in all cases the deficit to GDP ratio is improving and (recognising the last two years are forecasts) the UK appears to be reducing its deficit at an accelerating rate. On this measure we are close to getting back to where we were before the crisis - although of course our debt burden now is much greater and the UK's deficit rate is still materially worse than that of the Euro Area.

One last time; let's crowd the graph up;

We weren't in a great place in 2006. The combination of cost-side austerity and GDP growth is slowly coming to our rescue but on latest actual numbers we still have a deficit of concerning magnitude (for reference the EU's "excessive deficit" threshold is 3%). It's possible that reducing the tax burden is at least in part the driver of higher GDP growth - but it's yet to be shown whether that will truly deliver in terms of deficit reduction.

Focusing on the UK: it seems to me there's room to be a bit more aggressive on overall taxation levels and certainly opportunities to spread some of the pain away from the poorest in society; in return it looks like we could let our belt out a notch on expenditure to drive economic growth through investment.  Of course that - at its simplest - was the Labour Party's economic strategy going in to the last General Election.

Funnily enough it's also pretty much what the SNP's published economic strategy was too. Analysis by the IFS showed they basically matched Labour's more relaxed spending plans ...

... but (despite their cries of "social justice") were less willing to use tax increases as an economic lever.

Of course the SNP's rhetoric was that they were the only anti-austerity party6.  The IFS showed - and anybody paying attention already knew - the easy sound-bites were not supported by published policies.  So next time somebody tells you they're against austerity, maybe ask them what they actually mean by that.

It strikes me that being against austerity is like being against surgery: it's unpleasant, you only do it if you have to and there are a wide range of different procedures to choose from.  Not all cuts are the same.



1. As explained at least in part by Eurostat (Impact of support for financial institutions on government deficitsImpact of support for financial institutions on government deficits) bank capital injections were largely treated as "deficit increasing capital transfers (government expenditure)" and had a big impact on Euro Area Expenditure in 2010 and 2012 - these were calculated to increase Euro Area deficit by about 0.5% of GDP in each of those years and given spend/GDP is <50%, the direct  impact of the bailouts would only be about 2 index points on the Euro Area spending line. The impact in Ireland was much larger (20% of GDP in 2010) and was significant in Greece and Spain in (3 - 4%of GDP 2012).

2. This this makes up about 90% of the total government revenue for the UK and Euro Area, about 83% in the US.

3. Oil revenues went from 2.3% of UK revenue in 08-09 to 0.8% in 13-14 (per HMRC/GERS) so that would only explain roughly 1.5 points of index movement

4. It breaks down like this:
  -  Revenue/GDP  = (Tax burden/GDP + other revenues/GDP*) 
  -  Spend/GDP = (Spend.GDP + interest/GDP**)
  -  Deficit/GDP = Revenue/GDP - Spend/GDP

* In the UK these are fairly consistently about 4% or GDP, in the US 6-7% -- I've not dug into detail but I presume they include Gross Operating Surplus of state owned assets and proceeds from asset sales
** In the UK this was 2.0% of GDP in 2006, 2.7% in 2014

5. An annoying definitional idiosyncracy: Public deficit/surplus is defined in the Maastricht Treaty as general government net borrowing/lending according to the European System of Accounts (ESA95) - to all intents and purposes this means that we can treat "net borrowing/lending" as the same thing as "deficit". I've checked and the figures do indeed reconcile closely with the figures you'll find elsewhere n this blog using UK Government and GERS figures.

6. "48 Hours To End Austerity: SNP MPs will vote for an end to austerity and against Labour or Tory cuts"