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Articles for the ‘Essential Economics for Business: Ch 09’ Category

Going nuclear

The UK government has finally given the go-ahead to build the new Hinkley C nuclear power station in Somerset. It will consist of two European pressurised reactors, a relatively new technology. No EPR plant has yet been completed, with the one in the most advanced stages of construction at Flamanville in France, having experienced many safety and construction problems. This is currently expected to be more than three times over budget and at least six years behind its original completion date of 2012.

The Hinkley C power station, first proposed in 2007, is currently estimated to cost £18 billion. This cost will be borne entirely by its builder, EDF, the French 85% state-owned company, and its Chinese partner, CGN. When up and running – currently estimated at 2025 – it is expected to produce around 7% of the UK’s electricity output.

On becoming Prime Minister in July 2016, Theresa May announced that the approval for the plant would be put on hold while further investigation of its costs, benefits, security concerns, technological issues and safeguards was conducted. This has now been completed and approval has been granted subject to new conditions. The main one is that the government “will be able to prevent the sale of EDF’s controlling stake prior to the completion of construction”. This will allow the government to prevent change of ownership during the construction phase. Thus, for example, EDF, would not be allowed to sell its share of Hinkley C to CGN, which currently has a one-third share in the project. EDF and CGN have accepted the new terms.

After Hinkley the government will have a ‘golden share’ in all future nuclear projects. “This will ensure that significant stakes cannot be sold without the Government’s knowledge or consent.”

In return for their full financing of the project, the government has guaranteed EDF and CGN a price of £92.50 per megawatt hour of electricity (in 2012 prices). This price will be borne by consumers. It will rise with inflation from now and over the first 35 years of the power station’s operation. It is expected that the Hinkley C will have a life of 60 years.

Critics point out that this guaranteed ‘strike price’ is more than double the current wholesale price of electricity and, with the price of renewables falling as technology improves, it will be an expensive way to meet the UK’s electricity needs and cut carbon emissions.

Those in favour argue that it is impossible to predict electricity prices into the distant future and that the certainty this plant will give is worth the high price by current standards.

To assess the desirability of the plant requires an assessment of its costs and benefits. In principle, this is a relatively simple process of identifying and measuring the costs and benefits, including external costs and benefits; discounting future costs and benefits to give them a present value; weighting them by their probability of occurrence; then calculating whether the net present value is positive or negative. A sensitivity analysis could also be conducted to show just how sensitive the net present value would be to changes in the value of specific costs or benefits.

In practice the process is far from simple – largely because of the huge uncertainty over specific costs and benefits. These include future wholesale electricity prices, unforeseen problems in construction and operation, and a range of political issues, such as pressure from various interest groups, and attitudes and actions of EDF and CGN and their respective governments, which will affect not only Hinkley C but other future power stations.

The articles look at the costs and benefits of this, the most expensive construction project ever in the UK, and possibly on Earth..

Articles
Hinkley Point: UK approves nuclear plant deal BBC News (15/9/16)
Hinkley Point: What is it and why is it important? BBC News, John Moylan (15/9/16)
‘The case hasn’t changed’ for Hinkley Point C BBC Today Programme, Malcolm Grimston (29/7/16)
U.K. Approves EDF’s £18 Billion Hinkley Point Nuclear Project Bloomberg, Francois De Beaupuy (14/9/16)
Hinkley Point C nuclear power station gets government green light The Guardian, Rowena Mason and Simon Goodley (15/9/16)
Hinkley Point C: now for a deep rethink on the nuclear adventure? The Guardian, Nils Pratley (15/9/16)
Hinkley Point C finally gets green light as Government approves nuclear deal with EDF and China The Telegraph, Emily Gosden (15/9/16)
UK gives go-ahead for ‘revised’ £18bn Hinkley Point plant Financial Times, Andrew Ward, Jim Pickard and Michael Stothard (15/9/16)
Hinkley Point: Is the UK getting a good deal? Financial Times, Andrew Ward (15/9/16)
Hinkley Point is risk for overstretched EDF, warn critics Financial Times, Michael Stothard (15/9/16)
Hinkley C must be the first of many new nuclear plants The Conversation, Simon Hogg (16/9/16)

Report
Nuclear power in the UK National Audit Office, Sir Amyas Morse, Comptroller and Auditor General (12/7/16)

Questions

  1. Summarise the arguments for going ahead with Hinkley C.
  2. Summarise the objections to Hinkley C.
  3. What categories of uncertain costs and uncertain benefits are there for the project?
  4. Is the project in EDF’s interests?
  5. How will the government’s golden share system operate?
  6. How should the discount rate be chosen for discounting future costs and benefits from a project such as Hinkley C?
  7. What factors will determine the wholesale price of electricity over the coming years? In real terms, do you think it is likely to rise or fall? Explain.
  8. If nuclear power has high fixed costs and low marginal costs, how does this affect how much nuclear power stations should be used in a situation of daily and seasonal fluctuations in demand?
  9. How could ‘smart grid’ technology smooth out peaks and troughs in electricity supply and demand? How does this affect the relative arguments about nuclear power versus renewables?
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Consolidation amongst the high-street bookies

This time last year bookmakers Ladbrokes and Coral announced their intention to merge. This was closely followed by a merger between Betfair and Paddy Power. This wave of consolidation appears to have been partly motivated by the rise of online gambling, stricter regulation and increased taxation.

The UK Competition and Markets Authority (CMA) commenced an initial investigation into the Ladbrokes-Coral merger in late 2015 and, at the request of the merging parties, agreed to fast track the case to a detailed phase 2 investigation.

Despite the growth in the online market, the CMA’s investigation recognised the continued importance of high-street betting shops:

Although online betting has grown substantially in recent years, the evidence we’ve seen confirms that a significant proportion of customers still choose to bet in shops – and many will continue to do so after the merger.

The CMA identified almost 650 local markets where it believed there would be a substantial lessening of competition. It concluded that this could have both local and national effects:

Discounts and offers of free bets to individual customers are 2 of the ways betting shops respond to local competition which could be threatened by the merger. Such a widespread reduction in competition at the local level could also worsen those elements that are set centrally, such as odds and betting limits.

Therefore, earlier this week the CMA announced that before it is prepared to clear the merger, the parties must sell around 350 stores in order to preserve competition in the problem markets (many of these overlap so the number of store sales required is less than the number of problem markets). This divestment represents around 10% of the total number of stores currently owned by the two merging parties. It appears that rivals Betfred and Boylesports, plus a number of private equity investors, are already interested in purchasing the stores.

This may also not be the last consolidation in the industry with the struggling leading bookmaker William Hill apparently attracting merger interest from rival 888 in combination with a casino and bingo hall operator.

Articles
BHA warns CMA over Coral-Ladbrokes merger Racing Post, Bill Barber (7/7/16)
Ladbrokes-Gala Coral must sell 350-400 shops to clear merger BBC, (26/7/16)
William Hill is lukewarm on ambitious three-way merger deal The Telegraph, Ben Martin (25/7/16)

Questions

  1. Why might the merging parties in this case have been so keen to fast track the case to phase 2?
  2. What are the key factors in defining the market in this case? How do you think these would have affected the decision?
  3. Are there arguments that wider social issues in addition to the effect on competition should be taken into account when considering mergers in this market?
  4. Which of the potential purchasers of the divested stores do you think might be best for competition?
  5. How do you think this market will evolve in the future?
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A lorry load of fines

Record fines have been imposed by the European Commission for the operation of a cartel. Truck makers, Volvo/Renault, Daimler, Iveco and DAF have been fined a total of €2.93bn. The fines were considerably higher than the previous record fine of €1.7bn on banks for rigging the LIBOR rate.

Along with MAN, they were found to have colluded for 14 years over pricing. They also colluded in passing on to customers the costs of compliance with stricter emissions rules. Together these five manufacturers account for some 90% of medium and heavy lorries produced in Europe.

The companies have admitted their involvement in the cartel. If they had not, the fines might have been higher. MAN escaped a fine of €1.2bn as it had revealed the existence of the cartel to the Commission.

A sixth company, Scania, is still in dispute with the Commission over its involvement. Thus the final total of fines could be higher when Scania’s case is settled.

In addition, any person or firm adversely affected by the cartel can seek damages from any of the companies in the national courts of member states. They do not have to prove that there was a cartel.

The Commission hopes that the size of the fine will act as a disincentive for other firms to form a cartel. ‘We have, today, put down a marker by imposing record fines for a serious infringement,’ said Margrethe Vestager, the EU’s competition commissioner.

Also, by being able to exempt a cartel member (MAN in this case) from a fine if it ‘blows the whistle’ to the authorities, it will help to break existing cartels.

There are some other major possible cartels and cases of abuse of market power currently being considered by the Commission. These include Google and whether unfair tax breaks were given to Apple and Amazon by Ireland and Luxembourg respectively.

Articles
Price-Fixing Truck Makers Get Record E.U. Fine: $3.2 Billion New York Times, James Kanter (19/7/16)
Truckmakers Get Record $3.23 Billion EU Fine for Cartel Bloomberg, Aoife White (19/6/16)
EU fines truckmakers a record €2.93bn for running 14-year cartel Financial Times, Peter Campbell, Duncan Robinson and Alex Barker (19/7/16)
Truckmakers fined by Brussels for price collusion The Guardian, Sean Farrell (19/7/16)

Europa Press Release
Antitrust: Commission fines truck producers € 2.93 billion for participating in a cartel European Commission (19/7/16)

Information
Competition DG European Commission

Questions

  1. How have the various stakeholders in the truck manufacturing industry been affected by the operation of the cartel?
  2. What incentive effects are there, (a) for existing cartel members and (b) for firms thinking of forming a cartel, in the fining system used by the European Commission?
  3. Unlike the USA, the EU cannot jail managers for oligopolistic collusion. Compare the relative effectiveness of large fines and jail sentences in deterring cartels.
  4. What determines the profit-maximising price(s) for a cartel?
  5. Apart from the threat of action by the competition authorities, what determines the likely success of a cartel in being able to fix prices?
  6. Choose two other cases of possible cartels or the abuse of market power being examined by the European Commission. What is the nature of the suspected abuse?
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Transforming capitalism

Short-termism is a problem which has dogged British firms and is part of the explanation of low investment in the UK. Shareholders, many of which are large pension funds and other financial institutions, are more concerned with short-term returns than long-term growth and productivity. Likewise, senior managers’ rewards are often linked to short-term performance rather than the long-term health of the company.

But the stakeholders in companies extend well beyond owners and senior managers. Workers, consumers, suppliers, local residents and the country as a whole are all stakeholders in companies.

So is the current model of capitalism fit for purpose? According to the new May government, workers and consumers should be represented on the boards of major British companies. The Personnel Today article quotes Theresa May as saying:

‘The people who run big businesses are supposed to be accountable to outsiders, to non-executive directors, who are supposed to ask the difficult questions. In practice, they are drawn from the same, narrow social and professional circles as the executive team and – as we have seen time and time again – the scrutiny they provide is just not good enough.

We’re going to change that system – and we’re going to have not just consumers represented on company boards, but workers as well.’

This model is not new. Many countries, such as France and Germany, have had worker representatives on boards for many years. There the focus is often less on short-term profit maximisation and more on the long-term performance of the company in terms of a range of indicators.

Extending this model to stakeholder groups more generally could see companies taking broader social objectives into account. And the number of companies which put corporate social responsibility high on their agenda could increase significantly.

And this approach can ultimately bring better returns to shareholders. As the first The Conversation article below states:

This is something that research into a ‘Relational Company’ model has found – by putting the interests of all stakeholders at the heart of their decision making, companies can become more competitive, stable and successful. Ultimately, this will generate greater returns for shareholders.

While CSR has become mainstream in terms of the public face of some large corporations, it has tended to be one of the first things to be cut when economic growth weakens. The findings from Business in the Community’s 2016 Corporate Responsibility Index suggest that many firms are considering how corporate responsibility can positively affect profits. However, it remains the case that there are still many firms and consumers that care relatively little about the social or natural environment. Indeed, each year, fewer companies take part in the CR Index. In 2016 there were 43 firms; in 2015, 68 firms; in 2014, 97 firms; in 2013, 126 firms.

In addition to promising to give greater voice to stakeholder groups, Mrs May has also said that she intends to curb executive pay. Shareholders will be given binding powers to block executive remuneration packages. But whether shareholders are best placed to do this questionable. If shareholders’ interests are the short-term returns on their investment, then they may well approve of linking executive remuneration to short-term returns rather than on the long-term health of the company or its role in society more generally.

When leaders come to power, they often make promises that are never fulfilled. Time will tell whether the new government will make radical changes to capitalism in the UK or whether a move to greater stakeholder power will remain merely an aspiration.

Articles
Will Theresa May break from Thatcherism and transform business? The Conversation, Arad Reisberg (19/7/16)
Democratise companies to rein in excessive banker bonuses The Conversation, Prem Sikka (14/3/16)
Theresa May promises worker representatives on boards Personnel Today, Rob Moss (11/7/16)
If Theresa May is serious about inequality she’ll ditch Osbornomics The Guardian, Mariana Mazzucato and Michael Jacobs (19/7/16)
Theresa May should beware of imitating the German model Financial Times, Ursula Weidenfeld (12/7/16)

Questions

  1. To what extent is the pursuit of maximum short-term profits in the interests of (a) shareholders; (b) consumers; (c) workers; (d) suppliers; (e) society generally; (f) the environment?
  2. How could British industry be restructured so as to encourage a greater proportion of GDP being devoted to investment?
  3. How would greater flexibility in labour markets affect the perspectives on company performance of worker representatives on boards?
  4. How does worker representation in capitalism work in Germany? What are the advantages and disadvantages of this model? (See the panel in the Personnel Today article and the Financial Times article.)
  5. What do you understand by ‘industrial policy’? How can it be used to increase investment, productivity, growth and the pursuit of broader stakeholder interests?
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The Great Barrier Reef: a tragedy in the making

Australia held a general election on 2 July 2016. The Liberal/National coalition narrowly won in the House of Representatives, gaining a substantially reduced majority of 77 of the 150 seats, to Labor’s 68 and other parties’ 5 seats. One campaign issue for all parties was the destruction of the Great Barrier Reef, which is seen as an environmental disaster. Each party had proposals for tackling the problem and we examine some of them here.

The Great Barrier Reef is the largest coral reef in the world. As the BBC’s iWonder guide states:

One of the world’s seven natural wonders, the Great Barrier Reef contains some 900 islands and 3000 smaller reefs. It is larger than the UK, the Netherlands and Switzerland combined, home to around 10% of the world’s marine fish, over 200 bird species and countless other animals, including turtles and dolphins.

But this iconic Reef system is facing unprecedented threats. Together with governments, scientists are playing a key role in the battle to preserve this vulnerable ecosystem before it’s too late.

The Reef is 2300km long. In the northern third, around half of the coral is dead. Few tourists see this, as they tend to dive in the southern third, which, being cooler, is less affected.

The bleaching and destruction of coral reefs has a number of causes. These include: rising water temperatures, generally from global warming and more extreme El Niño events (rising warm waters that periodically spread across the Pacific); pollution, including that from coal mining, industrial effluent and run-off of pesticides, herbicides, fertilisers and sediment from farming, leading to acidification of waters; more frequent and more violent cyclones; rapidly expanding numbers of coral-eating Crown of Thorns starfish; and over fishing of some species of fish, leading to knock-on effects on ecosystems.

The Barrier Reef and the oceans and atmosphere around it can be regarded as a common resource. The warming of the atmosphere and the oceans, and the destruction of the reef and the wildlife on it, are examples of the ‘tragedy of the commons’. With no-one owning these resources, they are likely to be overused and abused. Put another way, these activities cause negative externalities, which do not appear as costs to the polluters and despoilers, but are still costs to all who treasure the reef. And, from a non-human perspective, it is a cost to the planet and its biodiversity. What is in the private interests of the abusers is not in the social or environmental interest.

The Australian government had sought to downplay the extent of the problem, afraid of deterring tourists – a valuable source of revenue – and under pressure from the coal and farming industries. Nevertheless, in the run-up to the election, the destruction of the Reef and what to do about it became a major debating point between the parties.

The Coalition government has pledged A$1bn for a new Reef fund, which will be dedicated to tackling climate change and water quality.

The fund will also help coastal sewage treatment plants to reduce ocean outfalls with efficient pumps, biogas electricity generation and next-generation waste water treatment. Improving water quality will enhance the Reef’s resilience to climate change, coral bleaching and outbreaks of the destructive crown of thorns starfish.

But how much difference the fund can make with the money it will have is not clear.

The Labor Party pledged to follow every recommendation in the Great Barrier Reef Water Science Taskforce’s Final Report, released in May, and to pass laws to prevent farm pollution flowing into the waters around the Reef and to have a more rapid shift towards renewable energy.

The Green Party goes the furthest. In addition to the Labor Party’s proposals, it wants to impose taxes on coal firms equal to the cost of the damage they are causing. The tax revenues would be paid into a multi-billion dollar fund. This would then be spent on measures to rescue the Reef, invest in clean energy projects, stop damaging industrial development, improve farm management and stop polluted run-off into the Reef catchment area by investing in water systems.

Promises at the time of an election are all well and good. Just how much will be done by the re-elected Coalition government remains to be seen.

Interactive Videos and presentations
David Attenborough’s Great Barrier Reef: an Interactive Journey, Atlantic Productions, David Attenborough (2015)
Global Warming – the greatest market failure Prezi, Yvonne Cheng (5/12/12)

Articles
The Great Barrier Reef: a catastrophe laid bare The Guardian, Michael Slezak (7/6/16)
The Guardian view on the Great Barrier Reef: the crisis they prefer to downplay The Guardian (7/6/16)
Fight to save Great Barrier Reef could cost billions, secret government modelling estimates ABC News, Mark Willacy (2/6/16)
Great Barrier Reef: government must choose which parts to save, says expert The Guardian, Joshua Robertson (8/7/16)
This election, what hope is there for the Great Barrier Reef? The Guardian, Michael Slezak (1/7/16)
Coalition will protect Great Barrier Reef with $1bn fund, says PM The Guardian, Gareth Hutchens (12/6/16)
Great Barrier Reef election explainer: how do the parties compare? The Guardian, Michael Slezak (2/6/16)
Five things we can do right now to save the Great Barrier Reef The Guardian, John Pandolfi (13/6/16)
We’ve scored the parties on the Reef My Sunshine Coast, Australian Marine Conservation Society (29/6/16)
Our Most Iconic Places Are Under Dire Threat From Climate Change Huffington Post, Nick Visser (26/5/16)
There are bright spots among the world’s coral reefs – the challenge is to learn from them The Conversation, Australia, Joshua Cinner (21/7/16)

Questions

  1. Explain what is meant by the Tragedy of the Commons. Is all pollution damage an example of this?
  2. What can the Australian government do to internalise the external costs to the Great Barrier Reef from (a) farming; (b) mining; (c) global warming?
  3. Why is it difficult to reach international agreement on tackling climte change? What insights can game theory provide for understanding the difficulties?
  4. What are the recommendations in the Final Report of the Great Barrier Reef Water Science Taskforce? What mix of tools does it suggest?
  5. What are the relative advantages and disadvantages of taxation, laws and regulations, public investment, education and international negotiation as policy instruments to protect the Reef?
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Is a competitive market the wrong model for analysing capitalism?

In the following article, Joseph Stiglitz argues that power rather than competition is a better starting point for analysing the working of capitalism. People’s rewards depend less on their marginal product than on their power over labour or capital (or lack of it).

As inequality has widened and concerns about it have grown, the competitive school, viewing individual returns in terms of marginal product, has become increasingly unable to explain how the economy works.

Thus the huge bonuses, often of millions of pounds per year, paid to many CEOs and other senior executives, are more a reflection of their power to set their bonuses, rather than of their contribution to their firms’ profitability. And these excessive rewards are not competed away.

Stiglitz examines how changes in technology and economic structure have led to the increase in power. Firms are more able to erect barriers to entry; network economies give advantages to incumbents; many firms, such as banks, are able to lobby governments to protect their market position; and many governments allow powerful vested interests to remain unchecked in the mistaken belief that market forces will provide the brakes on the accumulation and abuse of power. Monopoly profits persist and there is too little competition to erode them. Inequality deepens.

According to Stiglitz, the rationale for laissez-faire disappears if markets are based on entrenched power and exploitation.

Article
Monopoly’s New Era Chazen Global Insights, Columbia Business School, Joseph Stiglitz (13/5/16)

Questions

  1. What are the barriers to entry that allow rewards for senior executives to grow more rapidly than median wages?
  2. What part have changes in technology played in the increase in inequality?
  3. How are the rewards to senior executives determined?
  4. Provide a critique of Stiglitz’ analysis from the perspective of a proponent of laissez-faire.
  5. If Stiglitz analysis is correct, what policy implications follow from it?
  6. How might markets which are currently dominated by big business be made more competitive?
  7. T0 what extent have the developments outlined by Stiglitz been helped or hindered by globalisation?
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Avoiding taxes

Tax avoidance has been in the news since the publication of the Panama papers, which show the use of offshore tax havens by rich individuals and companies, partly for tax avoidance, partly for money laundering and other criminal activities – some by corrupt politicians and their associates – and partly to take advantage of lower regulation of financial dealing.

There are many tax havens around the world, including Switzerland, Hong Kong, British overseas territories (such as the British Virgin Islands, the Cayman Islands and Bermuda), Jersey, Singapore and certain US states (such as Arizona, Delaware, Nevada and Wyoming).

Here we focus on tax avoidance. This is the management of tax affairs by individuals or firms so as to avoid or minimise the payment of taxes. Tax avoidance is legal, unlike tax evasion, which is the practice of not declaring taxable income.

In a statement from the White House, directly after the publication of the Panama papers, President Obama spoke about the huge international scale of tax evasion and tax avoidance:

“A lot of it is legal, but that’s exactly the problem. It’s not that [people are] breaking the laws, it’s that the laws are so poorly designed that they allow people, if they’ve got enough lawyers and enough accountants, to wiggle out of responsibilities that ordinary citizens are having to abide by.

Here in the United States, there are loopholes that only wealthy individuals and powerful corporations have access to. They have access to offshore accounts, and they are gaming the system. Middle-class families are not in the same position to do this. In fact, a lot of these loopholes come at the expense of middle-class families, because that lost revenue has to be made up somewhere. Alternatively, it means that we’re not investing as much as we should in schools, in making college more affordable, in putting people back to work rebuilding our roads, our bridges, our infrastructure, creating more opportunities for our children.”

Tax avoidance, whether in tax havens, or through exploiting loopholes in the tax system may be legal. But is it fair?

Various principles of a tax system can be identified. These include:

Horizontal equity People in the same situation should be treated equally. For example, people earning the same level of income and with the same personal circumstances (e.g. number and type of dependants, size of mortgage, etc.) should pay the same level of income tax.
Vertical equity Taxes should be ‘fairly’ apportioned between rich and poor. The rich should pay proportionately more taxes than the poor.
Equity between recipients of government services Under the ‘benefit principle’, it is argued that those who receive the most benefits from government expenditure ought to pay the most in taxes. For example, it can be argued that roads should be paid for from fuel tax.
Difficulty of evasion and possibly of avoidance If it is desirable to have a given tax, people should not be able to escape paying.
Non-distortion Taxes alter market signals: taxes on goods and services alter market prices; taxes on income alter wages. They should not do this in an undesirable direction.
Convenience to the taxpayer Taxes should be certain and clearly understood by taxpayers so that they can calculate their tax liabilities. The method of payment should be straightforward.
Convenience to the government Tax rates should be simple to adjust and as cheap to collect as possible.
Minimal disincentive effects Taxes may discourage people from working longer or harder, from saving, from investing or from taking initiative. It is desirable that these disincentives should be kept to a minimum.

Of course, not all these requirements can be met at the same time. One of the most serious conflicts is between vertical equity and the need to keep disincentives to a minimum. The more steeply the rich are taxed, it is argued, the more serious are the disincentive effects on them likely to be (see the blog post from 2012, The 50p income tax rate and the Laffer curve). Another is between vertical equity and equity between recipients of services. Some of the people most in need of government support are the poorest and hence pay the least taxes.

The crucial question is what is regarded as ‘fair’. What is vertically equitable? According to the second article below, people’s preferred tax rates depend on how information is presented. If information is presented on how much tax is paid by the rich, people generally feel that the rich pay too much. If, however, information is presented on how much income people are left with after paying tax, people feel that the rich still have too much and ought to pay more tax.

The majority of people in the UK feel that tax avoidance, although legal, is morally wrong. According to the results of an HMRC survey in 2015, “the majority (63%) of respondents felt that the use of tax avoidance schemes was widespread. However, the majority (61%) also responded that it was never acceptable to use a tax avoidance scheme. The most frequent reason given as to why it was unacceptable was that ‘it is unfair on others who pay their taxes’.”

In making judgements about the fairness of tax, people generally have inaccurate knowledge about the distribution of income, believing that it is more equal than it really is, and about the progressiveness of the tax system, believing that it is more progressive than it really is. Despite this, they want post-tax income distribution to be more equal.

What is more, although people generally disapprove of tax avoidance, it is the system that allows the avoidance of taxes that they want changing. As long as it is possible to avoid taxes, such as giving gifts to children to avoid inheritance tax (as long as the gift is made more than seven years before the person’s death), most people see no reason why they should not do so themselves.

The following articles look at tax avoidance and people’s attitudes towards it. They are all drawn from The Conversation, “an independent source of news and views, sourced from the academic and research community and delivered direct to the public.”.

Articles
Explainer: what are ‘tax havens’? The Conversation, Tommaso Faccio (5/4/16)
When it comes to tax, how do we decide what’s fair? The Conversation, Stian Reimers (8/4/16)
Six things a tax haven expert learned from the Panama Papers The Conversation, Ronen Palan (6/4/16)

Documents
The Panama Papers The International Consortium of Investigative Journalists
Exploring public attitudes to tax avoidance in 2015: HM Revenue and Customs Research Report 401 HMRC, Preena Shah (February 2016)
2010 to 2015 government policy: tax evasion and avoidance HMRC/HM Treasury (8/5/15)

Questions

  1. Distinguish between tax avoidance and tax evasion.
  2. Give some examples of tax avoidance.
  3. Look through the various principles of a tax system and identify any conflicts.
  4. What problems are there in having a highly progressive tax system?
  5. What is a ‘shell company’? How can it be used to avoid and evade taxes?
  6. What are bearer shares and bonds? Why were they abolished in the UK in 2015?
  7. What legitimate reasons may there be for a company or individual using a tax haven?
  8. To what extent might increased transparency in tax affairs discourage individuals and companies from engaging in aggressive tax avoidance?
  9. What light does/can behavioural economics shed on people’s perceptions of fairness?
  10. How might the use of absolute amounts or percentages influence people’s thinking about the fairness of a tax system? What implications does this have for politicians in framing tax policy?
  11. In the principal–agent problem, where the principals are the tax authorities and the agents are taxpayers, why does asymmetric information arise and why is it a problem? How do the tax authorities seek to reduce this problem?
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Narconomics

In many cases, we simply leave the market to do what it does best – equate demand with supply and from this we get an equilibrium price and the optimal quantity. But, what happens if either the price or quantity is ‘incorrect’? What happens if the market fails to deliver an efficient outcome? In this case, we look to governments to intervene and ‘correct’ the market and such intervention can take place on the demand and/or supply-side. One area where it is generally felt that government intervention is needed is drugs and the trafficking of them across borders.

There are many ways in which governments have tried to tackle the problem of drug usage. The issue is that drugs are bad for individuals, for the community, society and the economy. Too much is produced and consumed and hence we have a classic case of market failure and this justifies government intervention.

But, how should governments intervene? With a substance such as drugs, we have an inelastic demand with resepect to price – any increase in price leads to only a small decrease in quantity. So any policy implemented by governments that attempts to change the market price will have limited effect in restricting demand. With globalisation, drugs can be moved more easily across borders and hence global co-operation is needed to restrict the flow. The article below considers the area of drugs and drug trafficking and looks at some of the policy options open to government.

Narconomics: The business of drug trafficking Houston Chronicle (16/3/16)

Questions

  1. Why does the market fail in the case of drug trafficking?
  2. Draw the demand curve you would expect for drugs and use this to explain why an increase in price will have limited effect on demand.
  3. Is there an argument for making drugs legal as a means of raising tax revenue?
  4. If better educational programmes are introduced about the perils of drug usage, how would this affect the market? Use a demand and supply diagram to help explain your answer.
  5. Why does globalisation make the solutions to drug trafficking more difficult to implement?
  6. Could drug usage and drug trafficking and hence the need to invest more money in tackling the problem actually boost an economy’s rate of growth? If so, does this mean that we should encourage drug usage?
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A soft target for a tax

Back in October, we looked at the growing pressure in the UK for a sugar tax. The issue of childhood obesity was considered by the Parliamentary Health Select Committee and a sugar tax, either on sugar generally, or specifically on soft drinks, was one of the proposals being considered to tackle the problem. The committee studied a report by Public Health England, which stated that:

Research studies and impact data from countries that have already taken action suggest that price increases, such as by taxation, can influence purchasing of sugar sweetened drinks and other high sugar products at least in the short-term with the effect being larger at higher levels of taxation.

In his Budget on 16 March, the Chancellor announced that a tax would be imposed on manufacturers of soft drinks from April 2018. This will be at a rate of 18p per litre on drinks containing between 5g and 8g of sugar per 100ml, such as Dr Pepper, Fanta and Sprite, and 24p per litre for drinks with more than 8g per 100ml, such as Coca-Cola, Pepsi and Red Bull.

Whilst the tax has been welcomed by health campaigners, there are various questions about (a) how effective it is likely to be in reducing childhood obesity; (b) whether it will be enough or whether other measures will be needed; and (c) whether it is likely to raise the £520m in 2018/19, falling to £455m by 2020/21, as predicted by the Treasury: money the government will use for promoting school sport and breakfast clubs.

These questions are all linked. If demand for such drinks is relatively inelastic, the drinks manufacturers will find it easier to pass the tax on to consumers and the government will raise more revenue. However, it will be less effective in cutting sugar consumption and hence in tackling obesity. In other words, there is a trade off between raising revenue and cutting consumption.

This incidence of tax is not easy to predict. Part of the reason is that much of the market is a bilateral oligopoly, with giant drinks manufacturers selling to giant supermarket chains. In such circumstances, the degree to which the tax can be passed on depends on the bargaining strength and skill of both sides. Will the supermarkets be able to put pressure on the manufacturers to absorb the tax themselves and not pass it on in the wholesale price? Or will the demand be such, especially for major brands such as Coca-Cola, that the supermarkets will be willing to accept a higher price from the manufacturers and then pass it on to the consumer?

Then there is the question of the response of the manufacturers. How easy will it be for them to reformulate their drinks to reduce sugar content and yet still retain sales? For example, can they produce a product which tastes like a high sugar drink, but really contains a mix between sugar and artificial sweeteners – effectively a hybrid between a ‘normal’ and a low-cal version? How likely are they to reduce the size of cans, say from 330ml to 300ml, to avoid raising prices?

The success of the tax on soft drinks in cutting sugar consumption depends on whether it is backed up by other policies. The most obvious of these would be to impose a tax on sugar in other products, including cakes, biscuits, low-fat yoghurts, breakfast cereals and desserts, and also many savoury products, such as tinned soups, ready meals and sauces. But there are other policies too. The Public Health England report recommended a national programme to educate people on sugar in foods; reducing price promotions of sugary food and drink; removing confectionery or other sugary foods from end of aisles and till points in supermarkets; setting broader and deeper controls on advertising of high-sugar foods and drinks to children; and reducing the sugar content of the foods we buy through reformulation and portion size reduction.

Articles
Sugar tax: How it will work? BBC News, Nick Triggle (16/3/16)
Will a sugar tax actually work? The Guardian, Alberto Nardelli and George Arnett (16/3/16)
Coca-Cola and other soft drinks firms hit back at sugar tax plan The Guardian, Sarah Butler (17/3/16)
Sugar tax could increase calories people consume, economic experts warn The Telegraph, Kate McCann, and Steven Swinford (17/3/16)
Nudge, nudge! How the sugar tax will help British diets Financial Times, Anita Charlesworth (18/3/16)
Is the sugar tax an example of the nanny state going too far? Financial Times (19/3/16)
Government’s £520m sugar tax target ‘highly dubious’, analysts warn The Telegraph, Ben Martin (17/3/16)
Sorry Jamie Oliver, I’d be surprised if sugar tax helped cut obesity The Conversation, Isabelle Szmigin (17/3/16)
Sugar sweetened beverage taxes What Works for Health (17/12/15)

Questions

  1. What determines the price elasticity of demand for sugary drinks in general (as opposed to one particular brand)?
  2. How are drinks manufacturers likely to respond to the sugar tax?
  3. How are price elasticity of demand and supply relevant in determining the incidence of the sugar tax between manufacturers and consumers? How is the degree of competition in the market relevant here?
  4. What is meant by a socially optimal allocation of resources?
  5. If the current consumption of sugary drinks is not socially optimal, what categories of market failure are responsible for this?
  6. Will a sugar tax fully tackle these market failures? Explain.
  7. Is a sugar tax progressive, regressive or proportional? Explain.
  8. Assess the argument that the tax on sugar in soft drinks may actually increase the amount that people consume.
  9. The sugar tax can be described as a ‘hypothecated tax’. What does this mean and is it a good idea?
  10. Compare the advantages and disadvantages of a tax on sugar in soft drinks with (a) banning soft drinks with more than a certain amount of sugar per 100ml; (b) a tax on sugar; (c) a tax on sugar in all foods and drinks.
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A Brazilian legacy?

It doesn’t seem long ago that we were looking at the prospects of Brazil for hosting the Football World Cup. Now, we turn to the same economy, but this time for the Olympics. It is often the case that hosting big global sporting events can give a boost to the host nation, but is Brazil prepared for it? Did the World Cup bring the expected economic boosts? Some argue that the Olympics is just what Brazil needs, but others suggest it will only worsen the economic situation in the world’s seventh largest economy.

Brazil’s economic performance in the past year was not good. In fact, it was one of the worst performing nations of any major economy, with GDP falling by 3%. This is a very different country from the one that was awarded this biggest of sporting events. Despite these difficult times, Brazil’s government maintains that the country is ready and that the games will be ‘spectacular’.

Key to hosting a sporting event such as the Olympics is the infrastructure investment and as a key component of aggregate demand, this should be a stimulant for growth and job creation. However, with the economy still struggling, many are concerned that the infrastructure won’t be in place in time.

Other benefits from this should be the boost to growth driven by athletes and spectators coming from around the globe, buying tickets, memorabilia, accommodation, food and other items that tourists tend to buy. A multiplier effect should be seen and according to research has the potential to create significant benefits for the whole economy and not just the local regions where events take place. You can look at similar analysis in blogs written about Tokyo: 2020 Tokyo Olympics and London: The London Olympics legacy: a cost–benefit analysis and Does hosting the Olympics Games increase economic growth?

But, is this really likely to happen, especially given the somewhat lacklustre boost that the Brazil World Cup gave to the economy? The following articles consider this.

Rio 2016: Can Games bounce back from Brazil economic woes? BBC News, Bill Wilson (11/03/16)
Does hosting the Olympics actually pay off? It’s the economy, Binyamin Applebaum (5/08/14)
Rio Olympics no help to Brazil economy based on World Cup Bloomberg, Raymond Colitt (16/01/15)
The economic impact of Brazil’s 2014 World Cup and 2016 Olympics Saxo Group, Trading Floor, Sverrir Sverrisson (27/08/12)
Special Interview: Cost–benefit analysis of hosting the World Cup, Olympics Al Arabiya, Ricardo Guerra (3/7/14)

Questions

  1. How might you carry out a cost–benefit analysis to decide whether to host a big sporting event?
  2. Are there any externalities that might result from hosting the Olympics? How easy is it to estimate their monetary value? Should this be taken into account by a country when making a decision?
  3. Why might there be a boost to aggregate demand prior to the Olympics?
  4. Why might there be a multiplier effect when a nation hosts the Olympics or another sporting event?
  5. Might there be benefits to Brazil’s neighbours from its hosting the Olympics?
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