A fantastic visual guide to the US Federal Budget.
Showing posts with label public spending. Show all posts
Showing posts with label public spending. Show all posts
Wednesday, 3 October 2007
Wednesday, 22 August 2007
Party like it's 1993
Just when you thought the Tories had not only got over Thatcher but Blair too off they go and bring back John Redwood to scare us all. He's behind a new report from the Competitiveness Council which amongst other things encourages the abolition of inheritance tax. Not surprisingly it's made quite a few headlines.
First the facts, then the rant. In the UK inheritance tax (IHT ) is payable at a rate of 40% on all estates over £300,000 (the nil rate band). The estate incurs the tax rather than the inheritors. So an estate of say £400,000 split evenly between four children incurs tax even though the individual shares may be below the nil rate band. Rising house prices and fiscal drag have seen more estates eligible for IHT in recent years. Still at last count it only affected 10% of estates and raised about £3.2bn - that's just under 1% of the total tax take but more than enough to pay for the work of Department of Environment, Food and Rural Affairs.
Redwood proposes abolishing the tax on the justification that:
And yes, abolishing inheritance tax would have an opportunity cost. It means higher taxes on wages, consumption or profits. Or reductions in spending. Redwood seems to think opposite, dragging out an argument that sounds quite like it's based on the Laffer Curve. There's good reasons for a tax system that rewards enterprise and lets clever, innovative individuals get rich. But IHT isn't a tax on people who've made a lot of money. It's a tax on people who haven't: their children.
However there are some reasons for reforming IHT. At the moment the same amount of tax is levied whether the estate is split between one or 10 children. A more equitable system would charge tax on the inheritor rather than the estate. But to hold receipts constant this would mean reductions in the nil-rate band. Also, IHT tax is borne disproportionately by the moderately rich. Seriously wealthy people are able to avoid inheritance tax by means of trusts and various offshore instruments. But is this a reason for repealing IHT? Hardly. The super-rich are already able to hide offshore and avoid all sorts of taxes well before their death.
For reasons that continue to elude me inheritance tax seems to provoke a visceral reaction out of all proportion to either it's scope or depth. While no one likes paying tax it seems perverse that people resent paying tax on windfalls more than they do on earnings. Perhaps this comes down to tax salience - essentially the visibility of the tax to the taxpayer. As people never even see their PAYE they don't consider it a loss. While the prospect of a the state taking a chunk of the family home is a much more visible intrusion.
I don't particularly mind vast personal holdings of wealth. However I do think that it capital should be put in the hands of the people best qualified to allocate it. In the long run that's the best way to drive productivity and growth. We should defer to the Sage of Omaha on this one. Three-time father Warren Buffett says that repealing inheritance tax would be like "choosing the 2020 Olympic team by picking the eldest sons of the gold-medal winners in the 2000 Olympics". And remember high IHT usually means low taxes on labour and profits. So if IHT means less lazy wealth-holders and more self-made millionaires then let's keep it.
PS: The resurgence of Redwood isn't the only thing that makes it feel like it's 1993. Ever heard of the EU working time directive? Apparently it's stifling British business. Yawn...........
First the facts, then the rant. In the UK inheritance tax (IHT ) is payable at a rate of 40% on all estates over £300,000 (the nil rate band). The estate incurs the tax rather than the inheritors. So an estate of say £400,000 split evenly between four children incurs tax even though the individual shares may be below the nil rate band. Rising house prices and fiscal drag have seen more estates eligible for IHT in recent years. Still at last count it only affected 10% of estates and raised about £3.2bn - that's just under 1% of the total tax take but more than enough to pay for the work of Department of Environment, Food and Rural Affairs.
Redwood proposes abolishing the tax on the justification that:
many people, who could not in any sense be described as rich, suddenly finding that their family will be liable to pay quite substantial amounts upon their estates.This is a quite extraordinary statement. Consider someone only just affected by IHT. Say he inherits an estate of £400,000 and will pay 40% of the amount over the nil rate band, leaving him with £360,000. Now we can quibble about the meaning of 'in any sense' and 'rich'. But £360,000 is a full fifteen times the UK median wage of about £23,600. And simply leaving this on deposit (probably not the best use of it) will pull him in £22,500 per year. So for doing absolutely nothing at all he'll pull in close that median wage yet again.
And yes, abolishing inheritance tax would have an opportunity cost. It means higher taxes on wages, consumption or profits. Or reductions in spending. Redwood seems to think opposite, dragging out an argument that sounds quite like it's based on the Laffer Curve. There's good reasons for a tax system that rewards enterprise and lets clever, innovative individuals get rich. But IHT isn't a tax on people who've made a lot of money. It's a tax on people who haven't: their children.
However there are some reasons for reforming IHT. At the moment the same amount of tax is levied whether the estate is split between one or 10 children. A more equitable system would charge tax on the inheritor rather than the estate. But to hold receipts constant this would mean reductions in the nil-rate band. Also, IHT tax is borne disproportionately by the moderately rich. Seriously wealthy people are able to avoid inheritance tax by means of trusts and various offshore instruments. But is this a reason for repealing IHT? Hardly. The super-rich are already able to hide offshore and avoid all sorts of taxes well before their death.
For reasons that continue to elude me inheritance tax seems to provoke a visceral reaction out of all proportion to either it's scope or depth. While no one likes paying tax it seems perverse that people resent paying tax on windfalls more than they do on earnings. Perhaps this comes down to tax salience - essentially the visibility of the tax to the taxpayer. As people never even see their PAYE they don't consider it a loss. While the prospect of a the state taking a chunk of the family home is a much more visible intrusion.
I don't particularly mind vast personal holdings of wealth. However I do think that it capital should be put in the hands of the people best qualified to allocate it. In the long run that's the best way to drive productivity and growth. We should defer to the Sage of Omaha on this one. Three-time father Warren Buffett says that repealing inheritance tax would be like "choosing the 2020 Olympic team by picking the eldest sons of the gold-medal winners in the 2000 Olympics". And remember high IHT usually means low taxes on labour and profits. So if IHT means less lazy wealth-holders and more self-made millionaires then let's keep it.
PS: The resurgence of Redwood isn't the only thing that makes it feel like it's 1993. Ever heard of the EU working time directive? Apparently it's stifling British business. Yawn...........
Sunday, 27 May 2007
Does private generosity harm the greater cause?
Or: Are private contributions offset by a greater decrease in public spending?
A reader asks me to place the claim I made in the concluding paragraph of my previous post in a formal setting in order to make clear what I meant (apologies to the readers who submitted requests for posts earlier - coming soon guys, promise). The paragraph in question is this:
'If the median voter knows that the higher the size of the deficit the more some citizens will voluntarily chip in, how do you think his decision on the size of the deficit will be affected? Yes, you conscientious citizens, you just made running a larger deficit the most appealing proposition.' This statement of course, depending on the extent my assumptions hold, can equally well apply to charitable giving, corporate social responsibility and the amount of household chores each of a group of housemates carry out.
While I am temporarily diverging from the customary style of this blog here, I have tried my best to keep this accessible to anyone with a year or two of economics education under their belts.
The simple (even simplistic) model below builds on standard models of public good provision. I examine what the equilibrium level of provision of the public good (call it 'clean air' if you like) is when it is provided both by government and the (perfectly competitive) private sector. Standard expositions of public good models focus on the equilibrium amount of the public good that would be provided by either voting or in a free market economy with no government under general conditions, while the aim here is to attempt to evaluate the implications of concurrent public provision and voluntary private purchases of the public good in a more restrictive setting.
I assume a closed economy with no growth. There is a finite number, n=3, of consumers/citizens. I label the three consumers as ‘left-wing’ (l), ‘median’ (m) and ‘right-wing’ (r). There are only two goods produced in this economy, a private good Yprv and a public good Ypub and there is no saving. For simplicity, I assume that there are no fixed costs of production and that the marginal cost of producing one unit of Yprv is the same as producing one unit of Ypub, with both being equal to one. This is not restrictive since the ‘units’ used are arbitrary. Also, there is perfect competition so that the price of goods equals their marginal cost.
Each individual has an endowment, Wi, and I further assume that there is perfect equality. One unit of this endowment can be used to produce either one unit of the public good or one unit of the private good.
Consumers are assigned simple Cobb-Douglas utility functions:
, i = l,m,r (1)
and I further assume that αi+bi = 1, αi, bi>0.
I define the median consumer/citizen simply to be the one that has the median α in the population of αi’s. Also, for ease of expression, I refer to the consumer/citizen that has a higher value of α, i.e a ceteris paribus higher preference for the public good, as being to ‘the left’ or being ‘left-wing’ and the consumer/citizen with the lower value of α as being to ‘the right’ or being ‘right-wing’.
The government provides Ypub with revenues obtained through taxation, and it selects the tax level in order to maximize the utility of the median voter.
Now, let’s suppose that the private sector is restricted to producing the private good only. The public good is provided solely by the government via taxation, which is required to be levied equally on every citizen. The level of tax (and thus the public good) is chosen to maximize the median voter’s utility.
All consumers (except the median voter) do not in any way choose their consumption bundle in this setup. The median voter (via the government) chooses the tax rate to maximize his own consumption and all other consumers simply contribute the amount of tax prescribed and spend the rest of their endowment on the private good.
Since this post is already unduly long, I will leave the equations determining the amount of the public good/taxation and each voter's utility as an exercise to the reader - for anyone interested, please email me and I will be happy to provide the answers.
To help get an intuitive feel for the results, the table below shows the values our variables take when we set w=100, αr=0.3, αm=0.5 and αl=0.7. The variable g refers to the amount of the public good purchased by the various individuals directly in the market (rather than provided by government via taxation), which in this case is zero for every consumer.
I will now turn to an alternative scenario, in which the private and the public good are both provided in a perfectly competitive environment, with consumers able to purchase goods at marginal cost. I model this as a sequential game of perfect information, in which the median voter selects the tax rate (which has to be equal for all citizens) and then all consumers decide the amount of the public good to purchase privately, on top of that provided via taxation.
Setting the values of the variables at the same level as in the previous example we have:
The tax rate, and the level of the public good, are now lower. The median voter and the ‘right-wing’ consumer are now better off, while the ‘left-wing’ consumer is worse off. In fact, even though we now have private contributions (by the ‘left-wing’ consumer) to the public good, the equilibrium amount of the public good is now lower than in the case with no voluntary contributions. Given our assumptions and perfect competition, introducing voluntary contributions increases the utility of the majority of the population but leads to a lower equilibrium amount of the public good.
This seemingly counterintuitive result makes perfect sense: knowing that the ‘left-wing’ consumer will find it beneficial to contribute more when the tax rate is lower, the median voter can gain by lowering the tax rate (and thus increasing his consumption of the private good and, incidentally, the ‘right-wing’ consumer’s consumption) and ‘free-riding’ on the ‘left-wing’ consumer’s contribution to the public good.
I have a hunch this may also help explain the pattern of charitable giving observed in the US: Americans have a very high level of private contributions per capita coupled with extremely lousy public funding of 'good causes' (look, for example, at donations for victims of the Tsunami). The relatively excess generosity of the private citizens is lower than the relative stinginess of the state compared to European countries, and America consistently comes out as a laggard when it comes to contributing to 'good causes'.
A reader asks me to place the claim I made in the concluding paragraph of my previous post in a formal setting in order to make clear what I meant (apologies to the readers who submitted requests for posts earlier - coming soon guys, promise). The paragraph in question is this:
'If the median voter knows that the higher the size of the deficit the more some citizens will voluntarily chip in, how do you think his decision on the size of the deficit will be affected? Yes, you conscientious citizens, you just made running a larger deficit the most appealing proposition.' This statement of course, depending on the extent my assumptions hold, can equally well apply to charitable giving, corporate social responsibility and the amount of household chores each of a group of housemates carry out.
While I am temporarily diverging from the customary style of this blog here, I have tried my best to keep this accessible to anyone with a year or two of economics education under their belts.
The simple (even simplistic) model below builds on standard models of public good provision. I examine what the equilibrium level of provision of the public good (call it 'clean air' if you like) is when it is provided both by government and the (perfectly competitive) private sector. Standard expositions of public good models focus on the equilibrium amount of the public good that would be provided by either voting or in a free market economy with no government under general conditions, while the aim here is to attempt to evaluate the implications of concurrent public provision and voluntary private purchases of the public good in a more restrictive setting.
I assume a closed economy with no growth. There is a finite number, n=3, of consumers/citizens. I label the three consumers as ‘left-wing’ (l), ‘median’ (m) and ‘right-wing’ (r). There are only two goods produced in this economy, a private good Yprv and a public good Ypub and there is no saving. For simplicity, I assume that there are no fixed costs of production and that the marginal cost of producing one unit of Yprv is the same as producing one unit of Ypub, with both being equal to one. This is not restrictive since the ‘units’ used are arbitrary. Also, there is perfect competition so that the price of goods equals their marginal cost.
Each individual has an endowment, Wi, and I further assume that there is perfect equality. One unit of this endowment can be used to produce either one unit of the public good or one unit of the private good.
Consumers are assigned simple Cobb-Douglas utility functions:
, i = l,m,r (1)and I further assume that αi+bi = 1, αi, bi>0.
I define the median consumer/citizen simply to be the one that has the median α in the population of αi’s. Also, for ease of expression, I refer to the consumer/citizen that has a higher value of α, i.e a ceteris paribus higher preference for the public good, as being to ‘the left’ or being ‘left-wing’ and the consumer/citizen with the lower value of α as being to ‘the right’ or being ‘right-wing’.
The government provides Ypub with revenues obtained through taxation, and it selects the tax level in order to maximize the utility of the median voter.
Now, let’s suppose that the private sector is restricted to producing the private good only. The public good is provided solely by the government via taxation, which is required to be levied equally on every citizen. The level of tax (and thus the public good) is chosen to maximize the median voter’s utility.
All consumers (except the median voter) do not in any way choose their consumption bundle in this setup. The median voter (via the government) chooses the tax rate to maximize his own consumption and all other consumers simply contribute the amount of tax prescribed and spend the rest of their endowment on the private good.
Since this post is already unduly long, I will leave the equations determining the amount of the public good/taxation and each voter's utility as an exercise to the reader - for anyone interested, please email me and I will be happy to provide the answers.
To help get an intuitive feel for the results, the table below shows the values our variables take when we set w=100, αr=0.3, αm=0.5 and αl=0.7. The variable g refers to the amount of the public good purchased by the various individuals directly in the market (rather than provided by government via taxation), which in this case is zero for every consumer.
I will now turn to an alternative scenario, in which the private and the public good are both provided in a perfectly competitive environment, with consumers able to purchase goods at marginal cost. I model this as a sequential game of perfect information, in which the median voter selects the tax rate (which has to be equal for all citizens) and then all consumers decide the amount of the public good to purchase privately, on top of that provided via taxation.
Setting the values of the variables at the same level as in the previous example we have:
The tax rate, and the level of the public good, are now lower. The median voter and the ‘right-wing’ consumer are now better off, while the ‘left-wing’ consumer is worse off. In fact, even though we now have private contributions (by the ‘left-wing’ consumer) to the public good, the equilibrium amount of the public good is now lower than in the case with no voluntary contributions. Given our assumptions and perfect competition, introducing voluntary contributions increases the utility of the majority of the population but leads to a lower equilibrium amount of the public good.
This seemingly counterintuitive result makes perfect sense: knowing that the ‘left-wing’ consumer will find it beneficial to contribute more when the tax rate is lower, the median voter can gain by lowering the tax rate (and thus increasing his consumption of the private good and, incidentally, the ‘right-wing’ consumer’s consumption) and ‘free-riding’ on the ‘left-wing’ consumer’s contribution to the public good.
I have a hunch this may also help explain the pattern of charitable giving observed in the US: Americans have a very high level of private contributions per capita coupled with extremely lousy public funding of 'good causes' (look, for example, at donations for victims of the Tsunami). The relatively excess generosity of the private citizens is lower than the relative stinginess of the state compared to European countries, and America consistently comes out as a laggard when it comes to contributing to 'good causes'.
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