Let’s face it – no-one likes paying tax! After all, to see your monthly pay decline by £1000 through taxation and national insurance has got to hurt. Yet, taxation and national insurance contributions are essential sources of government revenue to finance benefits and public and merit goods.
However, with so much attention given to the UK’s ‘culture of dependency’, many people are increasingly angry with having to pay so much in taxation to see it being spent by the government on individuals who in some cases choose not to work and at the same time seeing other rich people paying so little in taxation. The increase in the top rate of tax received a lot of coverage. Although it did make the tax system more progressive, there were many concerns that it would lead to lower growth, a lack of innovation and enterprise and increased tax evasion and avoidance, as the super-rich were being hit with phenomenal tax bills. The post on the 50p income tax available here is worth looking at again to think about the effect that taxes have on incentives.
The issue of tax avoidance is by no means new, but with a large budget deficit in the UK, tax avoidance by the super-rich has become something that everyone has an opinion on. The average household has seen its income squeezed more and more, as the government continues its efforts to cut the deficit. The fact that the super rich are avoiding sometimes millions in taxation, while the average household struggles to pay even the basic rate of tax, creates a rather contentious issue. The Chief Secretary to the Treasury, Danny Alexander, has said that the basic rate of tax could be cut by 2p in the pound if tax avoidance came to an end. He commented to the BBC’s Sunday Politics Programme that:
‘We have to make sure that everybody, especially the rich and famous, are paying their fair share of tax…These sorts of schemes that save wealthy people potentially tens of millions of pounds in tax, they are paid for by everybody else… If we could narrow the tax gap in this country by a quarter we could reduce income tax for every basic rate payer by 2p in the pound.’
This would clearly have some very positive effects on some of the poorest people living in the UK.
There is a variety of tax avoidance schemes available and the one receiving the most attention at present is the Jersey-based K2 scheme, which Jimmy Carr and others are thought to be using. The Public Accounts Committee will be reporting on the problem of using private companies to pay salaries, as a means of avoiding income tax and national insurance contributions.
If tax avoidance could be stopped, or at least reduced, then not only could basic rate tax payers benefit, but it might go some way to cutting the budget deficit, giving the government more flexibility in stimulating the economy. According to HMRC, tax avoidance and evasion cost the economy some £42 billion – enough to pay off one-third of Britain’s budget deficit.
The following articles consider the problem of tax avoidance and then try answering the questions on the issue of taxation.
Five-point plan to curb tax cheating by big firms and super-rich Guardian (27/6/12)
Stop tax dodgers or there will be ‘riots on the streets’, warns top lawyer designing new anti-avoidance rules Mail Online, Julian Gavaghan (26/6/12)
Danny Alexander describes aggressive tax avoidance as ‘morally repugnant’ Guardian, Patrick Wintour (24/6/12)
Basic tax ‘could be cut by 2p’ if avoidance ended BBC News(24/6/12)
Danny Alexander says tax avoidance ‘adds 2p in every £1 to basic tax rate’ Independent, Oliver Wright (24/6/12)
Make tax returns public, urges peer The Press Association (28/6/12)
Tax officials reveal scale of probe Financial Times, Jim Pickard (27/6/12)
Questions
- What are the key principles of a good tax system?
- Explain how taxation affects the incentive to work?
- What is the difference between tax evasion and tax avoidance?
- Using indifference analysis, illustrate the effect of a cut in the basic rate of income tax. How does it affect the decision to work more or less? You should consider the income and substitution effects in your answer and which rate of tax (if any) an individual is paying.
- Why is tax avoidance of such concern at the moment? Think about the current state of the economy.
- What are taxes and national insurance contributions used to pay for?
- To what extent do you think tax avoidance is a natural consequence of any tax system?
Youth unemployment has been one of the main headlines for some months, with data showing a record number of young people out of work.
As part of the government’s £1bn Youth Contract that aims to help young people back into work and help those unable to find employment, Nick Clegg has announced wage subsidies to firms hiring 18-24 year olds will be paid earlier.
Some of the costs of unemployment are obvious. For the individual who is unemployed, it means a lack of income and hence inability to buy goods and services. This then has wider implications for the economy. If people are unable to purchase goods and services, this contributes to a lower level of aggregate demand, which in times of recession, is hardly ideal.
Unemployment also means an inefficient use of resources, meaning the economy is operating below full capacity. Fewer people in work also implies lower tax revenues for the government, at the same time as higher unemployment benefit payments, contributing towards a growing budget deficit. This point is of particular concern, when it is young workers claiming benefits, as it could mean a life of dependency.
There are also some longer-term consequences, in particular for those who have been out of work for some time. They lose their skills, making it harder to find a job and this can pose costs to employers and further costs to the government through re-training. As such, government initiatives to tackle youth unemployment have never been more important.
The wage subsidies that were announced back in November will now be paid when young people have been out of work for six months, instead of nine. This initiative aims to help reduce youth unemployment in areas where it is at its worst. Twenty local authorities have been identified as priorities for the government and will benefit from this scheme. As Nick Clegg said to CBI summit:
“Three months can make all the difference. When you feel like your banging your head against a brick wall, when you live in an area where opportunities are already few and far between, another 12 weeks of rejection letters, of being cut off, of sitting at home waiting, worrying, that can seriously knock the stuffing out of you, making it extremely difficult to pick yourself up …
So jobcentres will be able to make use of the subsidy before people are referred to the Work Programme, capitalising on their links with local employers, and they’ll also intensify support, so more training, more regular coaching, spending more time with young people to knock a CV into shape or prep ahead of an interview.”
There are critics of the scheme, who argue that it is too little, too late and that it will simply displace older workers, thereby creating worse unemployment for another group. Until the economy begins to grow and confidence returns to the markets, unemployment is likely to remain a frequent headline. The following articles consider the wage subsidy and the state of unemployment in the UK.
Wage subsidy could mean more jobs Independent Online, Business Report, Pierre Heistein (14/6/12)
Wage subsidies scheme moved forward The Press Association (27/6/12)
Wage subsidy plan for young workers brought forward BBC News (27/6/12)
Wage subsidies scheme moved forward Independent, Alan Jones (27/6/12)
Nick Clegg announces extra help for jobless in 20 troublespots Guardian, Juliette Jowit (27/6/12)
Young people’s prospects have ‘nose-dived’ says report BBC News, Judith Burns (25/6/12)
Economic gap between young and old significantly worse since 2008 – study Guardian, James Ball and Helene Mulholland (25/6/12)
Questions
- Why is unemployment such a big concern for the UK economy? What is so important about youth unemployment?
- Which factors have contributed towards such high youth unemployment?
- How will the wage subsidy encourage firms to take on more young people? Think about how a rational firm behaves when choosing between 2 workers.
- Why does the wage subsidy cause concern for organisations supporting the employment of older workers?
- To what extent do you agree with the Guardian article that says that young people have borne the brunt of the recession and subsequent government cuts?
- What other things have been undertaken in a bid to reduce unemployment and stimulate the economy?
- Think about the costs of unemployment. Categorise them into costs to (a) the individual, (b) friends and family, (c) the government and (d) the economy.
The pensions crisis is one area of social policy that has been the focus of attention for some years. With an ageing population, more people entering higher education and a rather substantial deficit facing the government, pension reform has been high on the agenda and not just in the UK.
A number of factors have contributed towards the so-called pensions crisis: rising life expectancy; the ‘baby-boomers’ retiring; more people staying in education for longer; an ageing population. All of these have led to a dependency ratio that is becoming worse – fewer workers to support every pensioner. Over the past few years, strikes have taken place in protest to government pension plans, especially for public sector workers, who see the proposals as making them worse off once they retire. Doctors are the latest group to strike in protest over having to work longer before retiring and having to pay higher national insurance contributions.
So, are the doctors justified in their protests? They are currently on a final-salary pension scheme, which is a very generous scheme, although it is being phased out and replaced with a career average scheme, which will have big implications for doctors’ pensions. Furthermore, there was an overhaul of their pensions in 2008, thus the criticism that further changes are now being made to make them even worse off. Doctors do pay higher national insurance contributions than other occupations, such as teachers and they will naturally receive a higher pension than other NHS workers, such as nurses simply because they earn more. However, this does have big implications for their future.
Inequality is a big issue across the UK and this doesn’t only refer to income. Those earning higher salaries are more likely to live longer than the average worker. So, we see life expectancy inequality as well. The consequence of this is that once an individual retires at say 60, if your life expectancy is 85, then you have 25 years to live in retirement receiving whatever pension you have accumulated throughout your working life. If, however, your life expectancy is only 75, perhaps because of your background, your occupation, your health, then you will only spend 15 years in retirement. The person that lives longer therefore receives significantly more in pension payments and if this differing life expectancy is related to your occupation and thus your salary, then inequality of income clearly has some very wide implications for pension schemes and rates of contribution.
There are, of course, wider effects of any industrial action by doctors. Whilst some may agree with their view that this further pension reform is unfair, if any strike action does take place there will be wider economic effects. Those in need of treatment may have to delay it and if that means more people taking sick days, then the economic cost to the economy could be significant. The following articles consider the latest controversy in public-sector pensions.
Report
Independent Public Service Pensions Commission Final Report HM Treasury, Pensions Commission March 2011
Articles
Doctors’ strike: how the cost of NHS pensions soared Telegraph, Matthew Holehouset (21/6/12)
Are doctors’ pensions too generous Guardian, Hillary Osborne and Jill Insley (21/6/12)
Lansley: ‘Doctors’ pension scheme is generous’ BBC News (21/6/12)
Doctors get a nasty taste of Gordon Brown’s pension medicine Telegraph, Philip Johnston (18/6/12)
Doctors wrong on pensions, says Hutton Financial Times, Sarah Neville and Norma Cohen (19/6/12)
BMA ‘Inherent unfairness’ in doctor pensions BBC Radio 4 Today (21/6/12)
Reluctant move against intransigent government Scotsman, Dr Brian Keighley (21/6/12)
Will you be affected by the doctors’ strikes? BBC News (15/6/12)
Questions
- Explain the main factors that are contributing towards the so-called pensions crisis. In each case, is it a demand-side or supply-side issue?
- What are the main proposals to tackling the pensions crisis (not just for Doctors)?
- What is the difference between a career average and a final salary pension scheme? Which is better for (a) those on a higher salary at the end of their career and (b) those who are on a relatively lower salary at the end of their career? Make sure you explain your thinking!!
- What are the arguments both for and against this new round of pension reforms for doctors? Do you think the doctors are justified in taking strike action?
- What are the wider implications of industrial action? Think about the effect on individuals and on the economic performance of the wider economy.
- To what extent is it equitable that public sector workers should pay more in contributions and retire at the same age as the state pension age?
- How might higher contributions affect the incentive to work? What could we see happen to labour supply? Think about both income and substitution effects.
With globalisation, more and more businesses have found it beneficial to ‘go global’. There are many reasons why a firm might choose to expand its production or market to other countries and one particular advantage is cutting costs in the manufacturing of products.
Countries such as China and India have become leaders in production. Look at many of the items you own – I’m sure you’ll see a ‘Made in China’ or ‘Made in India’ amongst them. These fast emerging countries were highly sought after as places to produce due to much cheaper production costs. This advantage led to Western companies outsourcing much of their manufacturing base to China, as a means of retaining a competitive advantage.
However, the cost advantages that China boasted are now less significant and we may be about to see the emergence of a new manufacturing hub. Other countries that are further behind the BRICS in the development process now have cost advantages over places like China and so we may see another transfer of manufacturing to other parts of the world.
When splitting up a supply chain to gain cost advantages a key consideration is the extent to which you lose control. Communication and co-ordination issues can emerge when design takes place in one country; production in another and then the products are sold around the world. When cost differences are huge, these problems can be overlooked, as what they might cost you in terms of lost time etc. is easily made up by savings through cheaper labour.
However, when the cost advantages of production in China shrink, companies are still left with the problems of communication and co-ordination. These now represent more significant costs that could be reduced were production to revert to the country of design or if production were to be moved to an even cheaper country.
The following article from BBC News considers the issues surrounding the supply chain and how businesses may benefit from more collaboration.
Better collaboration lets businesses take back the supply chain BBC News, Alastair Sorbie (15/6/12)
Questions
- What are the arguments for becoming a multinational?
- Why do host countries, such as the BRICS accept inward investment? What do they gain from it?
- Explain how the product life cycle can affect the profitability of a MNC and how the company might respond.
- What are the disadvantages to a MNC from ‘going global’?
- What are the problems faced by developing countries acting as host nations?
- How has technology affected both big and small businesses?
No market is perfect and when the market mechanism fails to deliver an efficient allocation of resources, we say the market fails and hence there is justification for some government intervention. From a monopolist dominating an industry to a manufacturing firm pumping out pollution, there are countless examples of market failure.
The Guardian is creating a guide to climate change, covering areas from politics to economics. The problem of climate change has been well documented and this blog considers a particular issue – the case for climate change or the environment as a market failure. In many cases just one market failure can be identified, for example an externality or a missing market. However, one of the key problems with climate change is that there are several market failures: externalities in the form of pollution from greenhouse gases; poor information; minimal incentives; the problem of the environment as a common resource and the immobility of factors of production, to name a few. Each contributes towards a misallocation of resources and prevents the welfare of society from being maximised.
When a market fails, intervention is justified and economists argue for a variety of policies to tackle the above failures. In a first-best world, there is only one market failure to tackle, but in the case of the environment, policy must be designed carefully to take into account the fact that there are numerous failings of the free market. Second-best solutions are needed. Furthermore, as the problem of climate change will be felt by everyone, whether in a developed or a developing country, international attention is needed. The two articles below are part of the Guardian’s ultimate climate change guide and consider a huge range of economic issues relating to the problem of environmental market failure.
Why do economists describe climate change as a ‘market failure’? Guardian, Grantham Research Institute and Dunca Clark (21/5/12)
What is the economic cost of climate change? Guardian (16/2/11)
Questions
- What is meant by market failure?
- What are the market failures associated with the environment and climate change? In each case, explain how the issue causes an inefficient allocation of resources and thus causes the market to fail? You may find diagrams useful!
- What is meant by the first-best and second-best world?
- What does a second-best solution aim to do?
- Using diagrams to help your explanation, show how a tax on pollution will have an effect in a first best world, where the only market failure is a negative externality and in a second best world, where the firm in question is also a monopolist.
- What solutions are there to the problem of climate change? How effective are they likely to be?
- Does the need to tackle climate change require international co-operation? Can you use game theory to help your explanation?!
