Here’s a question that goes to the heart of economics and the social sciences generally: how desirable is the market system?
Our lives are dominated by markets. Whether in working or consuming, we operate in a market economy in which money is exchanged for goods or services. But also financial and product markets determine much of the structure of society, where most things seem to have a price.
But whilst, as a positive statement, we can say that money and markets are all around us, does that make them desirable? Markets provide signals and incentives; but are the signals the right ones? What are the incentives and how do we respond to them? And are these responses optimal?
You will probably have studied various ways in which markets fail to provide the optimal allocation of resources. But what are the limits of markets as a mechanism for social choices? And is there some more fundamental issue about the morality of a society that is organised around markets?
These are questions considered in the following podcast. It is an episode from BBC Radio 4’s Start the Week programme, hosted by Andrew Marr, with guests Michael Sandel, Diane Coyle and Grigory Yavlinksy. Here are the programme details:
Andrew Marr discusses the relationship between markets and morals with the political philosopher Michael Sandel. In his latest book, What Money Can’t Buy, Sandel questions the dominance of the financial markets in our daily lives, in which everything has a price. But the economist Diane Coyle stands up for her much maligned profession, and points to the many benefits of a market economy. The Russian economist Grigory Yavlinksy argues against viewing the world of money as separate from culture and society: he believes the financial crisis was merely a symptom of a wider moral collapse, and that it is time to examine the way we live.
(Links to the three contributors: Michael Sandel, Diane Coyle (see also), Grigory Yavlinsky.)
Podcast
Michael Sandel on Money and Morality BBC Start the Week programme (21/5/12)
Videos and articles
For a range of videos and articles on the morality of capitalism, see the previous post at:
We need to talk about Capitalism (28/1/12)
Questions
- What crises are there in current capitalism?
- What, according to Michael Sandel, is the difference between a market economy and a market society?
- Is the market society a relatively new phenomenon, or does it go back hundreds of years?
- To what extent is the greed expressed through markets and encouraged by markets affecting/infecting society and human relationships generally?
- What is the role of morality and trust in determining the desirability of market relationships?
- To what extent does a market economy allow people, rich and poor, to live separately from each other and not interact as joint members of society?
- What are the value systems promoted by marketisation? Should certain aspects of human life be outside these value systems?
- To what extent is the crisis of capitalism a crisis of economics?
- What policy alternatives are there for rebalancing society?
- What is the role of economists in advising on policy alternatives?
Calls for a simplified tax and benefit system have been ongoing and many see the Coalition’s plans for a Universal Credit as a step in the right direction. However, a second suggestion set out in a report by lobbying groups is to introduce a single rate of income tax at 30%. The argument is that it will simplify the system, help lower income earners and boost growth.
As well as the introduction of a single rate of income tax, The 2020 Tax Commission’s Report also suggests an increase in the personal allowance to £10,000; scrapping National Insurance Contributions, stamp duty, inheritance tax and air passenger duty, as well as cutting fuel duty by 5p. For the typical tax payer, it may sound great – the difference between your gross and your net pay would narrow, but the wider consequences must be considered. Although a single rate of income tax would undoubtedly simplify the system, the impact on government finances must be considered. The commission predicts that overall borrowing would fall by £35bn after 15 years, but that the national deficit would increase by £49.1bn in the first year. Perhaps not an ideal solution given the current state of the national deficit!
The report does contain some radical change, but the idea of simplification is well-recognised as a necessary principle of any tax system. As the Chairman of the Commission, Allister Heath said:
It is time for Britain to make a vital choice between tweaking the status quo and letting our economy continue to be crippled by complex and punitive taxes, and drastically changing course with a radical but realistic plan for a tax system fit for the 21st century.
The 2020 Tax Commission has set out that plan and would ensure that income is taxed once at a single, much more reasonable rate. It could create the conditions to establish the UK as a global trading hub, generating renewed prosperity for all those who live and work here.
The current system is complex and many people end up paying an extremely high rate of tax, once everything has been paid. The Guardian article below gives a nice illustration. “If you earn income from shares, first corporation tax is taken out of the profits. Then you pay taxes on the dividends. Then because those profits drive up the share price you pay capital gains tax as well.” With a simpler and fairer tax system, the Commission argues that it will boost the competitiveness of the UK economy and help boost its struggling growth rate. How many, if any, of these proposals will be incorporated into the government’s plans is anybody’s guess, but it definitely presents an interesting solution and problem.
Report
The Single Income Tax The 2020 Tax Commission (May 2012)
Articles
Why it’s time for a single income tax Guardian, Matthew Elliott (21/5/12)
Business backs income tax rate of 30% Financial Times, Martin Sandbu (21/5/12)
Calls for single 30% income tax rate BBC News (21/5/12)
Single 30% tax rate ‘essential’ for growth Sky News (21/5/12)
Osborne urged to introduce 30pc income tax for all The Telegraph, Tim Ross (20/5/12)
Tax shake-up urged to empower consumers and kickstart growth Independent, Russell Lynch (21/5/12)
The Tax Reform Britain needs Wall Street Journal, Matthew Sinclair (20/5/12)
Questions
- What are the key principles of a tax system?
- Explain why simplicity is so important when reforming a tax system. How can it affect the incentive to work?
- Would a 30% single rate of income tax be equitable?
- If the reforms set out in the report were to go ahead, what do you think would be the impact on goods and services provided by the government, such as the NHS, education, roads?
- 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.
- Why does the report argue that the reforms they suggest would help boost growth?
- How might the proposals affect government finances in both the short and long term?
According to the Sunday Times Rich List, the combined wealth of Britain’s 1000 richest people grew by nearly 4.7% last year to £414 billion (after growing by 18% in 2010).
This is in stark contrast to average households, who saw their real incomes decline by 1.9% in 2011. As the Guardian article below says:
The Rich Listers are not merely the 1%, but the 0.01%, and this fanfared celebration of their assets feels like a celebration of things that nobody feels like celebrating: bankers’ bonuses, complex corporate tax-avoidance structures, the stifling grip of aristocratic family wealth.
So why are the rich getting richer and what are the implications for society and the economy? Watch and read the following webcasts and articles and then see if you can answer the questions below.
Webcasts
Rich List shows how super-wealthy have dodged recession (or) Channel 4 News (29/4/12)
Sunday Times Rich List: Wealthy getting richer BBC News, Ben Thompson (29/4/12)
Articles
Britain’s richest see fortunes rise to record high Reuters, Tim Castle (29/4/12)
Sunday Times Rich List shows rich recover wealth twice as fast Myfinances.co.uk, Ben Salisbury (29/4/12)
Sunday Times Rich List suggests UK’s wealthiest defy recession BBC News (28/4/12)
Sunday Times Rich List 2012: Wealth of richest grows to record levels The Telegraph, Patrick Sawer (28/4/12)
The Not-So-Rich-Any-More List Guardian, Oliver Burkeman and Patrick Kingsley (27/4/12)
Sunday Times Rich List ITV News (29/4/12)
Data
Distribution of Personal Wealth HMRC
The effects of taxes and benefits on household income ONS (19/5/11)
Household Quarterly Release 2011 Q4 – Real household actual income and expenditure per head ONS
Questions
- Distinguish between stocks and flows. Which of the following are stocks and which are flows: income, wealth, savings, saving, expenditure, possessions?
- If the combined wealth of the 1000 wealthiest people increased in 2011, does this imply that their incomes rose? Explain.
- Why have the super rich got richer, while average incomes in the country have fallen?
- What are the costs and benefits to society (other than the super rich) of the super rich becoming richer?
- Distinguish between the income and substitution effects of an increase in income of the wealthy. Which is likely to be larger and why?
On 21 March, the Chancellor of the Exchequer, George Osborne, delivered the 2012 Budget for the UK. The details of the tax and benefit changes can be found in the Budget Report, with the Treasury’s summary of the tax changes here.
One of the key elements in the Budget was the reduction in the top rate of income tax from 50% to 45% from April 2013. The Chancellor argued that the introduction of the 50% rate in 2010 had raised very little extra tax revenue. Partly this was the result of people managing their tax affairs so that they could bring forward income to the year before the 50% rate was introduced – a practice known as forestalling. People are likely to do the reverse with the latest tax change and delay receiving income until next year. For details of the effects of forestalling, see the Office for Budget Responsibility’s Economic and fiscal outlook charts and tables Box 4.2a.
But part of the reason for the 50% tax rate raising relatively little has been the effect on incentives. A rise in the top rate of income tax can encourage people to move from the country – or move their incomes; it may discourage top earners from working more; it may encourage people to engage in various tax avoidance schemes; it may encourage people to evade taxes by not declaring all their income.
The effect of a rise (or fall) in the marginal income tax rate (t) on taxable income is given by the taxable income elasticity (TIE). This is defined as the proportionate change in taxable income (Y) divided by the proportionate change in the net-of-income-tax rate (r) (where r = 100 – t: i.e. the percentage of an extra pound that is not paid in income tax, but is retained by the taxpayer for spending or saving). TEI is thus ΔY/Y ÷ Δr/r. The larger the disincentive effect of raising taxes, the more will taxable income fall and hence the higher will be the value of TIE.
The Office for Budget Responsibility (OBR) in 2010 based its calculations on a TIE of 0.35 for the rise in the top marginal rate of income tax from 40% to 50%. This means that for each 1% fall in the net-of-income-tax rate, taxable income would fall by 0.35%. With a TIE of 0.35, the OBR calculated that the new top rate would bring an extra £2.9bn per year by 2011-12 (after allowing for any temporary residual effects of forestalling). However, the OBR now believes that the TIE is significantly higher and that the 50% rate will bring only an extra £0.7bn in 2011/12.
In its analysis of the effects of a cut in the top rate from 50% to 45%, the OBR has assumed a TIE of 0.45.
Turning to the costing of the move to 45 per cent, measured against our baseline that reflects the new information on the 50 per cent yield, we have endorsed as reasonable and central the Government’s estimate that the underlying cost would be around £0.1 billion in 2013-14, based on an assumed TIE of 0.45. The figure is as low as this because a TIE of 0.45 implies that the revenue-maximising additional tax rate is around 48 per cent. Moving from just above to just below this rate would therefore have very little revenue impact. Moving the additional rate back to 40 per cent would take it further below the revenue maximising rate and would thus be more expensive at roughly an additional £600 million. But for the reasons set out above we would again emphasise the huge uncertainties here.
Economic and fiscal outlook – March 2012 (p110)
The government’s arguments for reducing the top tax rate, therefore, are that it will have little effect on tax revenue, but would have a significant effect in encouraging inward investment, discouraging emigration of high earners and encouraging high earners to work more.
Articles
Rich tax cuts offset by changes to relief Financial Times, Vanessa Houlder (21/3/12)
Budget 2012: A big debate about small numbers (cont’d) BBC News, Stephanie Flanders (21/3/12)
Budget 2012: End of 50p tax, but 45p rate here to stay The Telegraph, Robert Winnett (21/3/12)
Budget 2012: Top income tax rate ‘won’t go any lower than 45p’ This is Money, Tim Shipman (22/3/12)
Why is tax avoidance a reason for letting people off tax? New Statesman, Alex Hern (22/3/12)
Study: Millionaires Don’t Flee States Due To Tax Hikes Think Progress, Pat Garofalo (22/3/12)
Laffer Curve Fun, with a side serving of nepotism Mark Wadsworth blog (22/3/12)
Budget 2012: are we really all in this together? Guardian, Polly Curtis (21/3/12)
Did the 50p tax rate really raise less than £1 billion in 2010/11? Touch Stone, Howard Reed (22/3/12)
45p: Power beats evidence Stumbling and Mumbling, Chris Dillow (22/3/12)
Reports, documents and presentations
Economic and fiscal outlook – March 2012 OBR
Budget 2012 HM Treasury (21/3/12)
Budget 2012 IFS (March 2012)
The Exchequer effect of the 50 per cent additional rate of income tax HMRC (March 2012)
Can More Revenue be Raised by Increasing Income Tax Rates for the Very Rich? IFS, Mike Brewer and James Browne (2009)
The 50p income tax rate IFS, James Browne (March 2012)
Questions
- What are the arguments for and against reducing the top rate of income tax from 50% to 45%? Do the same arguments apply to a further reduction to 40%?
- According to the OBR, at what top tax rate is the top of the Laffer curve?
- Why are the OBR’s calculations subject to considerable possible error?
- Why might a fall in the top tax rate from 50% to 40% not exactly reverse all the effects of an earlier rise in the top tax rate from 40% to 50%? In other words, why may the effects not be symmetrical?
- Distinguish between the income and substitution effects of a change in income tax rates. Which is assumed to be larger by the OBR in the case of reducing the top rate of income tax from 50% to 45%? Explain.
Since Labour’s historic pledge to eliminate child poverty in a generation, poverty data has been at the forefront of political debates. The recession has created unemployment and has moved more people below the poverty line, at the same time as causing rising inequality
The causes of poverty are diverse and a recent government commissioned report has drawn attention to just one of the key factors that is pushing more families into poverty – energy bills.
Fuel poverty has become more of a concern with the cost of household bills rising and this has led to calls for more money to be invested in cutting energy bills. Fuel poverty has been redefined by Professor John Hills, the author of the report, to focus on those households with a low income and also with relatively high energy bills.
Fuel poverty is undoubtedly concerning from a moral point of view – indeed, knowing that some families are unable to afford to heat their homes causes disutility for others. However, there are also wider economic implications. If families are unable to provide heating, this may adversely affect their children’s ability to learn and complete their homework, thus negatively affecting their productivity today and arguable causing further problems in their future. While this may have little effect today, the cumulative effect on economic productivity could be substantial in the long run. Inefficiency for the macroeconomy is therefore a problem, as a child’s productive potential will not be fully realized. Furthermore, there are also health concerns, as the government notes – fuel poverty is linked to 2,700 deaths per year. Again, this creates a blight on society, but it also poses economic problems, not least due to the strain on the NHS.
Fuel poverty has long been identified as a problem that needs addressing and as the Secretary of State for Energy and Climate Change said:
‘Fuel poverty is a serious national problem and this government remains committed to doing all it can to tackle it and make sure that the help available reaches those who need it most.’
Action is already taking place to insulate the poorest homes, as a means of cutting their energy bills and the government’s ‘Warm Homes Discount’ aims to provide help to the lowest income households in paying their bills. However, there are concerns that more households will move into fuel poverty, as this new definition doesn’t include those slightly wealthier households who still have high bills or the poorer households with relatively low bills. With the economy still in a vulnerable state, the latest data showing further rises in unemployment and household bills becoming increasingly expensive, the issue of fuel poverty is unlikely to disappear any time soon. The following articles consider this issue.
Fuel poverty seen for 3 million households by 2016 Reuters (16/3/12)
Fuel poverty to rise to 8.5m, report warns (including video) BBC News, Damian Kahya (15/3/12)
Nine million will live in ‘fuel poverty’ in the next four years Independent, Simon Read (16/3/12)
Fuel poverty to rise sharply Telegraph, James Hall (16/3/12)
Call for urgent action on fuel poverty Financial Times, Sarah Neville (15/3/12)
Fuel poverty worse than estimated The Press Association (15/3/12)
3 million fuel-poor households by 2016, report claims Guardian, Mark King and Zammy Fairhurst (15/3/12)
Questions
- What are the causes of poverty?
- How has the definition of fuel poverty changed? Is the change a good one? Think about the equity and efficiency of such a change.
- The BBC News article says that government measures to alleviate fuel poverty could be regressive. What is meant by this and why could this be the case?
- What are the economic consequences of fuel poverty?
- We can estimate poverty by looking at the poverty headcount or the poverty gap. What is the difference between these two measures? Which one is a more accurate measure of poverty?
- Are there any other actions that you think would be effective in alleviating fuel poverty? Would they be cost effective?
- Why does Age UK fear ‘the current proposals to improve energy efficiency through the Green Deal and energy obligation schemes are a woefully inadequate response to one of the most serious issues facing our country today’?
Here’s a question that goes to the heart of economics and the social sciences generally: how desirable is the market system?
You will probably have studied various ways in which markets fail to provide the optimal allocation of resources. But what are the limits of markets as a mechanism for social choices? And is there some more fundamental issue about the morality of a society that is organised around markets?
