The Jimmy Carr Affair and the British Tax System

“The art of taxation,” observed John-Baptiste Colbert, Treasurer to King Louis XIV in France, “consists in so plucking the goose as to obtain the largest number of feathers with the least possible amount of hissing.”

The recent bout of moral outrage regarding the tax affairs of Jimmy Carr and other celebrities has resulted in a great deal of hissing for very few feathers. Colbert would not have approved.

The question is – at whom should we be hissing?  Are the real villains of the piece the celebrities using legitimate means open to them to minimise their tax payments, or the system that allows them to do so?  In the lead front-page article in today’s Times, Sir Terry Leahy, former chief executive of Tesco, is quoted as saying that, “if taxpayers are unhappy with the law, then the answer is to change the law.” The same article reports that HMRC is now so overwhelmed with tax disputes and tribunals that it would take 38 years to clear the backlog at the present rate.

The truth is that the real problem lies with the immensely complex system of reliefs, allowances and special provisions inherent within the current UK taxation regime. This provides a bonanza for tax lawyers and accountants – whose undoubted talents would be far better deployed on more productive enterprise – while generating distortions that undermine the productivity of the British economy.

What is required is a radical and comprehensive overhaul of the current taxation system. An alternative system, raising the same amount of revenues, could be based on a simple 20:20:20 structure – setting the basic rate of VAT, income tax and corporation tax all at 20% – while doing away with the plethora of reliefs, allowances, and special payments that have built up over the years. Within this system, the basic Old Age Pension would be increased, and the personal tax allowance set at £10,000 – so the first £10,000 on anyone’s income would be tax free.  Around the core 20:20:20 system, I would propose two layers. A higher rate of income tax of 40% would apply for those earning above a certain threshold.  And a reduced rate of VAT of 5% would apply to labour-intensive services such as hairdressing and out-of-home meals.

Incidentally, following my May 31st comment on the Pasty Tax and the VAT rate on food, provisional estimates have been made of the total fiscal impact of applying a standard 5% VAT rate to all processed and prepared food.  These estimates indicate that it could generate a modest increase in VAT receipts for the Exchequer. This is on the basis that net grocery sales are currently running at approximately £160 billion a year – the UK being the only EU Member State apart from Ireland that does not charge VAT on groceries, under the “temporary” concession of 1975.  Under my proposals, fresh food would still be free of VAT, whereas prepared food would accrue a 5% rate. A first-order estimate is that prepared and processed food accounts for a quarter of all food sold in supermarkets, bakeries and other shops. On this estimate, extending a 5% VAT rate to all prepared food would generate a net receipt of approximately £2 billion for the Exchequer (= £160 billion x 25% x 5%).

The central point is that a simplified tax structure need not cost money.  It would broaden the scope of the taxation base, make tax avoidance more difficult, eliminate the distortions and inefficiencies inherent in the current system, and be regarded as fairer by those to whom it applies (i.e. you and me).  Indeed, over time, the dynamic stimulus that a fairer and more efficient fiscal regime would give to productivity would stimulate growth and increase the UK’s taxation base.

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The Economic Consequences of Greek Exit from the Euro

With just over a week to go before the Greek General Election, it is reported that the left-wing Syriza Party may emerge with the most seats and be invited to form a government led by Alexis Tsipras.  His economic policy is based on two pillars:

1. Greece should remain within the Euro.

2. However, Greece should not continue the policies of austerity pursued by the government of George Papandreou to comply with the EU’s fiscal compact, which would require Greece to balance its budget. Instead, Mr Tsipras proposes the creation of 100,000 public sector jobs and writing off part of the country’s debt.

There is a logical third implication of this syllogism:

3. Germany and the other Eurozone countries should transfer sufficient resources to Greece to enable the Government to meet its public spending and debt servicing obligations.  Without this, the Greek Government could become insolvent.

[3]  is not going to happen. In an excellent presentation given to the David Hume Institute in Edinburgh yesterday evening, the Prime Minister of Lower Saxony, Mr David McAllister, made it very clear that, whatever his personal sympathy for the predicament of the Greek people, there was no possibility that he or his national party leader, Angela Merkel, could sell such a proposal to their voters. He pointed out that the retirement age in Germany had only recently been raised to 67, against strong trade union opposition, and there was absolutely no way that German voters would support subsidies to the Greek Government to enable it to maintain an average retirement age of 61.

Given these political realities, the most likely outcome is eventual Greek exit from the Euro.

The consequences of such an exit are a matter for debate.  Nikolaos Karamouzis of Eurobank was quoted in the Sunday Times on May 20th as saying, “We depend on EU and European Central Bank funding to pay our back our debts and keep everything from banks, to hospitals, to the traffic lights working. If the EU stops funding us, we will simply run out of money and the economy will stop functioning.” In the “armageddon scenario” painted by the Sunday Times, “an implosion in Greece would spread to Portugal, Ireland, Italy and Spain, sparking runs on their domestic banks….Stock markets would crash….There would be a flight of capital from weak to strong countries, necessitating exchange controls.  Governments might seize assets held by foreigners.  Inflation would soar in Europe’s periphery, but core nations could suffer deflation….Unemployment would soar.  Public services would fail….House prices would plummet…”

However, such a nightmare scenario is not borne out by historic precedent. Twenty years ago, Britain exited the European Exchange Rate Mechanism – the precursor to the Euro.  Sterling did indeed drop significantly in value, as a new Greek Drachma would against the Euro. But Britain did not descend into social and economic chaos.  On the contrary, the years following ERM exit saw a sustained recovery in output, income and employment in the UK.  I believe that the same would happen in Greece.  The price of Greek agriculture, manufacturing and tourism would fall as a result of a Drachma devaluation against the Euro. After an initial shock, the Greek balance of payments would gradually improve – just as the UK balance of payments did in the mid-1990s – as exports became more competitive, while domestic production became cheaper relative to imports. As in Britain after the ERM exit of September 1992, the most likely scenario is that the Greek economy would trace a “J” curve – an initial downturn followed by gradual and sustained recovery.

The adjustment process would be eased if transitional assistance were provided to Greece by the IMF as part of an orderly exit, as proposed by the highly respected Chairman of the House of Commons Treasury Select Committe, Andrew Tyrie MP, in a paper published by the Centre for Policy Studies on June 5th.

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The “Pasty Tax” and VAT on Food in the UK

The news that the British government has decided to rescind its ill-conceived “pasty tax” – the 20% VAT rate levied on hot pasties and other hot food served by bakers introduced in the budget eight weeks ago – comes as a welcome relief, not just for Cornish pasty manufacturers, but more widely for the British economy.

The initiative had all the hallmarks of a poor tax – raising modest amounts of revenue (just £40 million per annum), expensive and complicated to administer (how would the taxman be able to check whether a pasty was hot enough to be taxed?) and threatening significant job losses.

But in fairness to the Chancellor of the Exchequer and his Treasury team, there was a rationale for the tax – namely, to eliminate anomalies in the current UK VAT system as it applies to food. These anomalies still remain. A hot sausage roll served by a baker will now attract zero VAT, provided it is being allowed to cool naturally (how on earth is the VAT man going to monitor this?) while the same hot sausage roll served in a fish and chip shop will be taxed at 20%. Unless, of course, the fish and chip shop has an annual turnover of between £77,000 and £150,000 a year, in which case it would benefit from a flat rate of 12.5%, or less than £77,000, in which case it would not need to register for VAT at all. Similarly for sandwiches – if served cold in a supermarket, there is zero VAT, but if the same sandwich “has been heated for the purposes of enabling it to be consumed at a temperature above the ambient air temperature” then it is taxed at 20%.  Then there is the age old riddle – “when is a cake not a cake?” McVitie’s were keen to prove that their Jaffa cake was in fact a biscuit, and thus should have a 0% VAT rate. In a landmark 1991 case that generated substantial fees for our friends in the legal profession, HMRC won the argument and proved to the Court’s satisfaction that a Jaffa cake is not a biscuit but a cake (the clue is in the name) and thus liable to VAT at the standard rate of 20%.

How can these distortions be eliminated?

My proposal would be to apply a standard zero rate of VAT to fresh food – fruit, vegetables, bread, eggs, fresh fish and meat – wherever served; while applying a 5% VAT rate to any prepared food, whether hot or cold. This would include sandwiches, sausage rolls whether hot or cold, biscuits and cakes, and restaurant meals.

The application of a standard 5% VAT rate to all prepared food and out-of-home meals would generate the following benefits:

1. It would broaden the tax base, by bringing all prepared food into the VAT umbrella, wherever it is served.
2. It would end the distortions and anomalies that exist within the current system.
3. It would do so in a cost-effective manner, with few likely to object to a 5% rate.
4. In overall terms it would have little impact on retail price index. The RPI might actually decrease slightly as the price of food served in restaurants, cafés and pubs would fall, as would the price of certain types of food served in supermarkets (e.g. cakes!).
5. It would provide a modest incentive to home cooking using fresh ingredients, which would become 5% cheaper than ready-made microwaved meals.
6. It would create jobs. President Sarkozy’s decision to reduce the rate of VAT on French restaurant meals from 19.6% to 5.5% in July 2009 (since increased to 7%) helped to save an estimated 30,000 cafés which were struggling financially, and to create 100,000 new jobs during a period of economic recession. Restaurants, cafés, catering firms and pubs are highly labour-intensive, so any stimulus they get from a more competitive tax regime will feed through quickly to new jobs.
7. On my calculations, a reform of the VAT regime along these lines would be almost fiscally neutral from the outset. In other words, the gain to the Exchequer from broadening the tax base, reducing unemployment benefits, and increasing income and corporation tax from the restaurant and catering sector would more or less offset the direct loss in VAT yields. Over time, the stimulus given to out-of-home meals could actually increase the Exchequer’s total tax take.

In summary, a standard 0% rate on all fresh food and 5% rate on all processed food would help make the UK VAT system simpler, more efficient and more productive, while creating new jobs and providing an important stimulus to the economy during a period of austerity.

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The Euro and the Spanish banking crisis

The origins of the Spanish banking crisis date back to the fateful decision taken by the Spanish Government in 1999 to surrender the peseta and adopt the euro. For a time, it seemed as though the euro would bring prosperity to the Iberian peninsular, as interest rates fell to German levels and property prices soared, financed by rapid growth in bank credit. Lending to the real estate sector rose to more than €650 billion, or around two thirds of Spain’s GDP. But after the credit crunch of 2007/08, the flow of new lending dried up and Spanish property prices collapsed, leaving Spanish banks with mounting bad debts. As of May 2012, loans in arrears had risen to 8.4% of total real estate lending, with a further increase likely over time.

In early May 2012, Spain’s fourth-largest bank, Bankia, collapsed under the weight of bad debts. On May 7th, the Spanish Government announced that it would step in to rescue Bankia, with an injection of €4.5 billion in new equity to take a 45% stake in the bank.

The news did little to calm the markets. Yields on Spanish government debt rose to more than 6%, as investors’ concerns grew that the government would struggle to balance its budget in line with the requirements of the Eurozone’s fiscal compact, which could ultimately threaten Spain’s membership of the Eurozone.

“The battle for the euro is going to be waged in Spain,” Spain’s Finance Minister, Luis de Guindos, was quoted as telling the Financial Times on May 19. “It is a large economy with an orthodox government implementing orthodox policies.”

But the Spanish Government’s orthodox attempts to reduce the deficit by yet more spending cuts and higher taxes are likely to drive the Spanish economy deeper into slump. Already, one in four of the Spanish population is registered as unemployed, and one in two of its young people are without a job – a lost generation, whose life chances are being blighted by the Spanish Government’s slavish adherence to the euro, and the orthodox policies needed to support membership, no matter what the wider social cost. It is difficult to see how the Spanish economy can recover in a situation where the banking sector is struggling to contain mounting bad debts, stifling the flow of credit to new enterprise, and where exports are held back by the uncompetitiveness of Spanish industry within the rigid straitjacket of the single currency.

The most likely outlook is that economic activity will continue to decline and unemployment will continue to rise, eroding the tax base and increasing the burden of social welfare payments. The Spanish Government is trapped in a sovereign debt death spiral that is likely to end in default, and ultimately in Spanish exit from Euro.

Although it is likely to take some time, it would appear that the ill-starred euro experiment is now entering its end game. The question is – how will it unravel, and what will take its place?

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The German Finance Minister proposes a solution to the Eurozone crisis

As the Eurozone crisis deepens, the German Finance Minister, Wolfgang Schäuble, has come up with an interesting proposal to help resolve it. He has suggested that the real wages of German workers should be significantly increased. An increase in real wages would increase their spending power, and hence the level of imports that German consumers are able to buy from their neighbours. This would have the beneficial effect of increasing demand for the goods and services produced by France, Spain, Italy, Greece and the other Eurozone countries, helping to stimulate their economies and reduce their payments deficits.

“It is fine if wages in Germany currently rise faster than in other EU countries,” he stated in a magazine interview on May 6th. “These wage increases also serve to reduce the imbalances within Europe.”

But there’s a rub. The German Finance Minister has no direct power to increase the real wages of German workers. And Mr Schäuble’s statement earned an immediate rebuke from the Chairman of the German Employers’ Federation, who said it was no business of politicians to meddle in wage setting decisions, which should be determined by employers and workers.

Both men are right. The Employers’ Federation is right to warn against political interference in wage negotiations. Equally, the Finance Minister is right to say that the real wages of German workers need to be increased.

So how can the impasse be resolved?

Back in the days before the Euro, the German Finance Minister could have achieved a real wage increase throughout the German economy through an upward revaluation of the Deutschmark. The Chairman of the Employers’ Federation would have accepted that this was a matter of macro-economic policy, rightly determined by the German Government.

What is required is a return to this system through the creation of a core Eurozone comprising Germany, the Benelux countries, Austria and Finland. Their currency could then be revalued upwards against the national currencies of the PIIGS (Portugal, Ireland, Italy, Greece and Spain). This would automatically achieve the increase in the real wages of German workers that Mr Schauble recognises is necessary.  It would also correct the terms of trade between Germany, which is running a large and persistent payments surplus, on the one hand; and the PIIGS, which are experiencing large and unsustainable payments deficits, on the other.

The current policy of austerity, which requires the PIIGS to tackle their deficits by Draconian spending cutbacks, will only make their economic situation worse. By contrast, an alternative strategy involving an orderly currency realignment would achieve a rebalancing much more easily, avoiding the social distress now being experienced across much of the Eurozone..

This, in my judgement, is exactly what is now required. The problem is that, within the rigid straitjacket of the single currency, such a rebalancing is not possible. And so the Eurozone crisis drags on.

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The President-Elect of France as a German Satrap

It has not taken long for François Hollande to receive a hard lesson on the limits of French presidential power in 2012. Less than 24 hours after being elected President of France, M. Hollande’s eminently sensible proposal to re-examine the terms of the Eurozone fiscal compact negotiated by his predecessor has been rejected out of hand by Angela Merkel. The compact was agreed in a desperate attempt by Merkozy to reassure financial markets that Eurozone governments would be able to service their sovereign debt. Just a few short months on, it is becoming increasingly apparent that it has failed to achieve this objective, with Spanish and Italian sovereign bond yields creeping up to levels widely regarded as unaffordable by their respective governments and taxpayers. No matter. The German Chancellor has decreed that there is no possibility of relaxing a compact whose inspiration owes more to Hans Christian Andersen than to John Maynard Keynes. Indeed, the only prediction that an economist can confidently make about the compact – which stipulates that Eurozone governments will at all times limit their budget deficits to a maximum of 0.5% of their GDP – is that its chances of realisation are precisely zero. Yet the mere suggestion by President-elect Hollande that the terms of the compact should be revisited as part of his pro-growth strategy earned him an immediate ticking off by the German Chancellor. And so we are witnesses to a remarkable phenomenon – the proud heir to King Louis XIV, the Emperor Napoleon, General Charles de Gaulle – and, yes, Nicolas Sarkozy – as French Head of State is reduced to a mere satrap of the German Chancellor – before he has even taken the oath of office!

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François Hollande elected President of France – an end to austerity?

Elections in France and Greece on May 6 saw voters reject policies of austerity in both countries. In France, President-elect Hollande has stated that he will seek to amend the Eurozone’s fiscal compact, under which euro members have committed themselves to reducing their national budget deficits to no more than 0.5% of GDP – very sensibly, in the light of the fact that France’s budget deficit is currently running at almost 5% of GDP. But other aspects of his platform look uncannily like a retread of the policies introduced by his Socialist predecessor François Mitterrand when he first took office, which unravelled within a couple of years – a “tax and spend” strategy including 75% income tax on the rich, high State spending, and a higher minimum wage. The question is, how is all this going to be financed? Presidents come and Presidents go, but the National Debt goes on forever – and in France’s case the Hollande strategy seems certain to further increase government debt, leading to a rise in French bond yields and a fall in the value of the Euro against other major currencies.

Over the longer term, the anti-austerity strategies that have garnered electoral support in both France and Greece may prove difficult to implement within the rigid straitjacket of the Euro. The most likely medium-term consequence may be further instability in the Eurozone, perhaps hastening the day predicted in The Golden Guinea when the Euro itself proves to be untenable in its current form.

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