Friday, 30 March 2012

Funding political parties

The latest cash-for-access scandal has attracted renewed interest to the report on party-political finance published in November by the Committee on Standards in Public Life, subtitled "ending the big donor culture".  The report makes 24 recommendations, the most important being to ban donations to a party from any one source of more than £10,000 a year,  and to replace at least part of the lost income with a subsidy from the public purse proportional to votes received in the last general election, to be awarded to any party qualifying for Policy Development Grants: currently this means with at least two sitting MPs, but the report recommends extending to grants to parties with significant representation in the devolved legislatures.  The report recommends that parties not qualifying for state subsidy should be exempt from the cap on donations.

I think the case for public funding is overwhelming.  The estimated cost would be £23m per year.  UK government spending is expected to be about £683bn.  I think it would be extraordinary if the need to encourage donations didn't induce a government to make inefficient spending decisions amounting to much more than 0.0034% of its budget.

Opponents are concerned that restrictions on donations would inhibit the emergence of new parties.  They may have overlooked that recommendation 23 in the report is that "The donation cap should not apply to political parties without enough representation to qualify for Policy Development Grants, or the equivalent we have proposed in the devolved legislatures."  I would extend that to allow any party to opt out of the cap, in return for renouncing state funding and renouncing the possibility of any of its MPs holding ministerial office until after the next general election but one.

The other objection is that politicians don't deserve the money.  But this is not a question of what the politicians deserve; it's a question of what sort of government we all want.  I want one that can make decisions without consulting the party treasurer first.

Tuesday, 27 March 2012

Oil futures

Cormac Hollingsworth has a piece on Left Foot Forward in which he complains that Financial Services Bill doesn't do enough to give the Bank of England the information it needs to regulate the market.  He recommends in particular an amendment "that includes important extensions to improving the transparency of the UK’s commodities markets, to make public for the first time the true level of risk taking".

Hollingsworth is concerned in particular about pension-fund investments in commodities, "facilitated by a financial innovation, the Commodity Index Fund, invented by Goldman Sachs in the 1990s using the same financial technology of swaps that gave us the synthetic CDOs that sold sub-prime mortgages round the world" (I'm struggling to think of two financial products more dissimilar than the GSCI and a synthetic CDO).  He points out - in bold text - that when banks sell these products "they take no risk, take a fee and pass on the risks to their customers".  Does he mean that the reason it's important to highlight the "true level of risk taking" by the banks is that it's not high enough?

The question Hollingsworth most wants answered is "why is it that for the past year, UK oil prices – the Brent oil price – has been 10.7p a litre higher than the equivalent American traded oil price?".  I'm not an expert on the oil market, so to help understand the issue I downloaded some oil price data from here (the equivalent US benchmark to Brent Crude is WTI - West Texas Intermediate) , FX rates from here, looked up how many litres there are in a barrel, and drew this chart:

Certainly the price difference is large for two commodities with very similar intrinsic value.  But I don't think it can reasonably be said that it's been 10.7p/litre for the past year.

Hollingsworth describes the difference as an "enormous squeeze on UK consumers and businesses". But is it?  Are US consumers and businesses getting cheaper petrol ('gasoline') thanks to the cheaper WTI crude price? Here's a chart, using data from the same source, of US wholesale gasoline prices compared with crude oil prices:

There's little difference between NY and Gulf gasoline prices, and both are typically a little more expensive than Brent Crude (refining costs something).  What stands out is that as WTI falls below Brent, gasoline prices show no sign of tracking it.  WTI benchmark crude is not a major raw material in the production of gasoline for the major US markets, and most US consumers and businesses are getting little or no advantage from its relative cheapness.  (But retail prices are much lower in the US than in Europe because taxes are much lower.)

What's actually happening is that the WTI crude benchmark is taken from the price in Cushing, Oklahoma.  And the way things are currently set up it's much easier to get oil to Cushing than to get it out.  So there's a glut there and the market is depressed.  As a pricing benchmark, it's broken.  As Tim Worstall points out, one can get the gist of this from Wikipedia.

I do know something about Commodity Indexes*.  Investors buy them because they think commodity prices, and especially oil prices, will go up as demand increasingly exceeds supply.  The Index managers buy commodity futures, which is what the indexes track.  That pushes up the futures price, so that the Brent market was pushed into 'contango' - the forward price higher than the spot price - for nearly three years up to the end of October last year.  This encouraged arbitrageurs to buy oil and sell oil futures against it, pushing up spot oil prices.

So traders have responded to the expectation of future oil shortages by storing oil for future use.  That makes oil for immediate use more expensive.  In other words, we're saving some of a limited resource for the future when we expect to need it.  Why would anyone be opposed to that?

Incidentally, the chart illustrates the absurdity of blaming the US president for high gasoline prices, as opposition speakers - currently Republican presidential candidates - are wont to do.  The president does not control global oil prices, and no amount of drilling or pipeline construction in the USA is likely to change that.  The deeply unattractive Newt Gingrich in particular promises if elected to reduce prices to $2.50 per US gallon, compared with the present level of about $3.85, which is just over a dollar a litre.  He's lying.

*This blog does not offer specific investment advice.  But if you're thinking of putting money into a Commodity Index, find out how its rules instruct it to roll from one future to the next as time passes, and to what extent that allows arbitrageurs to make profits at its expense.

Saturday, 24 March 2012

Intellectual-property rights: software patents

The purpose of intellectual-property rights is to encourage the creation of new intellectual property.  The cost to us all is that they impoverish us by restricting the use of non-rivalrous goods.

How does this apply to software patents?  Are they necessary to encourage people to write software?  Absolutely not.  I have never met a programmer with the slightest interest in patent protection other than resentment of the difficulty of trying to avoid infringements.  Are they necessary to make software patent lawyers rich?  Very probably.  The only other defence I can find of the system is that it lets rich countries (the US) extract rents from less rich countries.  We can live without that.  And I'm not even sure there's a net benefit to the US, given the amount of effort US companies put into suing each other over alleged patent infringements.  Bill Gates wrote (p5) in a Microsoft internal memo in 1991
 If people had understood how patents would be granted when most of today's ideas were invented, and taken out patents the industry would be at a complete standstill today
Perhaps the most famous example is Amazon's "1-click" patent.  Would Amazon have developed the technology if no patent protection had been available?  Of course they would.  The effect of the patent was that Barnes & Noble had to add an extra click to their on-line checkout: presumably many other sites did the same to avoid being sued.  Nothing good resulted and the internet was made slightly worse.

Let's abolish software patents now.

Tuesday, 20 March 2012

Someone is wrong on the internet

Having advised myself to leave Richard Murphy alone, here I go again.  I've had a conversation with him on his blog.  Stripping out other lines of discussion (from me in the first post, from him thereafter) it went like this:

Me: You keep repeating that HMRC’s figures imply the 50% rate raises an additional £6.7 billion, but you know that’s not true, because you did your calculation on total income ignoring tax reliefs.
RM: No I did not do my income on total incomes ignoring tax reliefs. I did it on their estimate of those paying the 50-p tax rate – i.e. after tax reliefs
Me: Have another look at the HMRC table. The first column is labelled “Range of total income”. It’s pretty obvious that this includes tax reliefs, because not all the people earning over £150,000 are paying Additional Rate tax. Your calculations use the column “Total income of taxpayers”: it’s pretty obvious that includes tax reliefs too because it would be absurd to be inconsistent about it, and because otherwise the “Average amount of tax” numbers would be too low.
RM: But I only considered the tax paid by those paying at 50%. And therefore you’re wrong. And I note the fact that I allowed for this in doing my calculations. But no doubt you did not read the report I wrote.
Me: I’m looking at p19 of your report. Let’s take the row for taxpayers with total incomes over £1mn. You find an average income for them by taking their total income (which I think we agree includes tax reliefs) and dividing by the “Number of taxpayers in income bracket”. Then you subtract £150k to get “Part of income subject to 50% tax rate on average”. You take a tenth of that to find the effect of cutting the rate to 40%. At no point in that calculation do you subtract anything for tax reliefs.
RM: Because I don’t need to do so – HMRC have.
Me: Are you saying that “Total income” in the HMRC table is really “Income net of allowances and reliefs”?
RM: Tell me what else it is
Me: It’s total (declared) income.
RM: And as I’ve pointed out – I’ve allowed for that. Please stop wasting my time.

Does he think the total income data he used are for total income, or does he think they're net of tax allowances and reliefs?  He says he doesn't have to subtract tax reliefs because HMRC have done it already.  Then when I tell him the HMRC data is for total income, he says he's allowed for that.  It's as if he thinks it doesn't matter what the numbers mean, the calculation will magically work correctly anyway, because he "only considered the tax paid by those paying at 50%".

Ah well, someone is wrong on the internet.  If you think it's me, please do explain.

Update: I had another conversation with him, in the comments to this post (which is much worse than the relatively small error I was banging on about above).  I recognize that it was foolish of me to do so.  I'm adding this note mainly as a reminder to myself never to do it again.

UK credit outlook

Last week Fitch announced that its review of the UK's sovereign credit rating had decided to keep it at AAA but revise the outlook to 'Negative', meaning that it's more likely than not that it will decide on an actual downgrade in the next two years.  In February Moody's had done much the same thing (it has slightly different criteria).  The agencies are concerned in particular about the possibility of further adverse affects on the UK from the Eurozone crisis.

This is rather embarrassing for George Osborne and the Conservative Party - the first of the eight "benchmarks" in its 2010 election manifesto was "We will safeguard Britain's credit rating...".  But Osborne, being a politician, said that it shows he's right "This is proof that, in the current global situation, Britain cannot waver from dealing with its debts".  I suppose that had there been no negative outlook that would have shown him to be right also.

Fitch and Moody's give considered analyses of why it's reasonable to be cautious about prospects for the UK economy, and they're right.  But what they don't do is say what that's got to do with the likelihood of a default, which is what credit ratings are supposed to be about.  Countries can default for one of two reasons: either they can't pay, which can happen only if they issue debt in a currency they don't own, or they won't pay because the rulers don't want to.  Thus Greece has defaulted because its government couldn't get hold of enough euros to pay its debts (you might think it could have taken more extreme measures: it could have tried selling a few Mediterranean islands if it could find sufficiently wealthy and thick-skinned buyers).  Whereas the US was rightly downgraded last year by S&P because its politicians showed that in some circumstances they might choose not to pay.

Neither of these possibilities applies to the UK: politicians of both parties have shown no interest whatever in  a voluntary default, and willingness to support the bond market by buying bonds with (electronically) printed money - they can create all the pounds they need.  It's possible that in dire economic circumstances the pound would be severely devalued in order to pay the debt, but that should be no business of the ratings agencies: bond investors can hedge with FX forwards if they wish.

I'm struggling to work out what sovereign credit ratings are supposed to be for.

Monday, 19 March 2012

Income distributions and Additional Rate taxpayers

Richard Murphy (whom I really ought to leave alone after this post) notes that the HMRC tables of income tax projections imply a 9.1% increase in taxpayers with incomes over £150k in 2011-12 compared with 2010-11, whereas the numbers had been fairly flat over the previous four years.  On this evidence he accuses the Treasury of "fraudulent manipulation of data".  (He seems to use the terms 'Treasury' and 'HMRC' interchangeably.)

Fraud, whether intended in a legal sense or not, is a serious charge.  Murphy ought to be more considerate of HMRC's employees: one reason is that many them are members of trade unions affiliated to the TUC, for which he wrote his recent report.

It's also an implausible charge.  What are the incentives for such a fraudulent manipulation of data?  It's hard to see how they could outweigh the disincentive of potentially being found out and sacked.  I very much doubt that there is the sort of culture of dishonesty at HMRC that would make a fraudster feel safe.

Murphy says that the projected increase "looks wrong" and (in the comments) "is utterly implausible".  I don't share his faith in his gut instincts: I'd rather take a look at the data.  I suppose that HMRC has got a model which starts with an income distribution and applies some income inflation (which need not be the same at all income levels) and some increase or decrease in numbers (which again need not be the same at all income levels).  So I've had a try at reproducing the distribution for 2010-11.

As Murphy reports, "It is assumed that 9.1% more people come into this bracket that year, and earn 9.6% more as a result".  That is, there is almost no change in the average income of people in the bracket.  That's characteristic of the Pareto (power-law) distribution often used to model the upper tail of incomes.  If one assumes that all incomes over £150k follow such a distribution, then to fit the average of those incomes, which is £344k, one needs a power of 1.773.  This gives the following results:
Range  Actual Number  Modelled Number 
150k-  146,000  131,00
200k-  143,000  158,00
500k-   26,000   27,000
1mn+   13,000   11,000
It's not a perfect fit, but it's not terrible. Extending the distribution backwards by another 30,000 taxpayers (i.e. the 9.1% growth) I get to an income of £142.8k. So an income growth of 5.04% would be required to give the projected growth in the number of taxpayers with incomes over £150k.

The literature on income distributions suggests that they are well fitted by a power-law distribution in the upper tail and by a lognormal distribution elsewhere.  The power-law distribution does seem to be favouring the £200k+ range over the £150-200k range, so I tried fitting a lognormal distribution to the data, and got this:
Range  Actual Number  Modelled Number 
6475-  933,000  951,00
7500- 2,610,000 2,808,000
 10k- 6,380,000 6,122,000
 15k- 5,160,000 5,267,000
 20k- 6,910,000 6,923,000
 30k- 5,690,000 5,484,000
 50k- 2,120,000 2,233,000
100k-  344,000  198,000
150k-  146,000  30,000
200k-  143,000  9,000
500k-   26,000     27
1mn+   13,000      0
It's about the right shape except for the high-end tail, where it falls off too quickly.

Finally, I tried fitting the sum of a lognormal distribution and a Pareto tail applying from 1k up:
Range  Actual Number  Modelled Number 
6475-  933,000  923,000
7500- 2,610,000 2,763,000
 10k- 6,380,000 6,116,000
 15k- 5,160,000 5,308,000
 20k- 6,910,000 6,992,000
 30k- 5,690,000 5,505,000
 50k- 2,120,000 2,195,000
100k-  344,000  362,000
150k-  146,000  109,000
200k-  143,000  138,000
500k-   26,000   36,000
1mn+   13,000   27,000
It's not unexpected that simply adding distributions doesn't work perfectly, and one wouldn't in any case expect a perfect fit to real world data (I suppose that HMRC data for 2010-11 are at least influenced by reality).  Anyway, for this fit I need to go down to an income level of £142k to get an extra 30,000 taxpayers, implying an income growth rate of 5.7%.

So having fitted the data two ways, we find an implied income growth rate for high earners of between 5.0% and 5.7%.  How implausible is that?  CPI annual growth peaked at 5.2% in September 2011 and RPI annual growth at 5.6%.   Private sector wage inflation peaked at 3.4% in June 2011.  However, income inflation is not uniform, and the CEBR reports that bankers' salaries have risen faster.  Overall, I would be somewhat surprised if HMRC were proved right about the numbers with incomes over £150k in 2011-12, because it's not obvious why this year should be different from previous years.  But I think it would be easy to create a plausible model of income distributions and growth that reproduces HMRC's prediction.  HMRC may be wrong, but there is no reason to think it dishonest.

Oh, and Murphy should stop telling people "you really do have to improve your maths".

Saturday, 17 March 2012

Rich people giving money to charity

I am sympathetic in principle to the use of progressive taxation to reduce inequality.  But it would be a good thing if proponents of the cause had a better understanding of how money works.  Here's one mind-boggling piece of stupidity from page 30 of Richard Murphy's analysis for the TUC of the 50% tax rate, in a footnote about tax relief for gifts to charity:
Higher rate taxpayers personally benefit from this tax relief. Anybody who is a taxpayer can give money to a charity under the Gift Aid scheme. If that is done the charity can reclaim the basic rate tax paid by the taxpayer from HM Revenue & Customs. For a basic rate taxpayer that is the end of the story. For each £1 they give the charity claims back the basic rate tax at 20% - meaning they reclaim 25p (the £ given is net after tax so the pre tax amount presumed to be given is £1 divided by 80% which is £1.25, with 25p being the tax reclaimed). For a higher rate taxpayer this is not the end of the story. If they put the gift on their tax return then they get tax relief for the donation at their full marginal rate of tax. So a 50% rate tax payer who gives £1 to a charity under Gift Aid is still deemed to have paid over £1.25 with the charity reclaiming the 25p in tax but the taxpayer claims relief on the higher rate sum at 50%, meaning that they can claim a refund of 62.5p. The charity has already had 25p so the higher rate tax payer cannot get that back and so instead they benefit by 37.5p (62.5p less 25p). This means that 50p taxpayers actually personally benefit by tax refunds of greater amount than a charity does when they gift money to charity.
The first sentence is nonsense.  Giving a pound to charity and getting 37.5p back isn't a personal benefit, it's a cost of 62.5p.

When I earned a salary that Murphy would think outrageous, I used a Payroll Giving scheme, by which my employer paid a monthly amount from my gross salary into a charity account in my name, from which I made donations to charity.  Income tax was deducted from my salary net of this amount.  It's pretty hard to detect where I can be said to have benefited personally from the tax relief.  Payroll Giving works differently to the mechanism Murphy describes in that the charity can't claim Gift Aid: I don't think it meaningful to say that I was getting it.

What Murphy means, if he means anything, is that it costs a higher-rate or additional-rate taxpayer less of their net income to give a pound to charity than it costs a basic-rate taxpayer.  If you see this as purchasing a sense of inner virtue, something like buying indulgences, then that does reduce the price.  On the other hand, a rich person probably needs to make a larger donation to achieve a given level of contentment from it. Similar considerations would apply to the benefit if any of being seen to give the money (Matthew 6:3 has pertinent advice).  And few of us think givers to charity deserve to have their motives closely examined.

Murphy's views on tax reliefs generally seem to assume that whatever the prevailing scales of income tax happen to be, those scales applied to one's gross income give a sum which is rightfully the property of the state, and any relief is therefore a gift from the state to the taxpayer.  It's far from obvious to me that this is the best way to look at it.

Thursday, 15 March 2012

How much does the 50% rate collect?

Last Friday the TUC published Richard Murphy's analysis of how much extra tax will be collected in 2011-12 by the UK's 50% top rate, assuming zero elasticity of taxable income. His answer (on p19) based on HMRC's published estimates is £6.789bn: on the next page he reduces this to "between £3 billion and £6 billion a year", for reasons not stated.

Earlier in the week I gave a one-line calculation based on data from the same HMRC table which gives the number as £6.1bn.  So who is right?

The answer, naturally enough, is neither of us.  It's impossible to work this out exactly from the information given, but Murphy fails to account for two relevant factors and I overlook one of them (my excuse is that I was merely showing how Murphy should have avoided the crass error in the calculation he implied he was doing).

First, tax relief, especially on pension contributions.  Murphy talks about such reliefs at some length starting on page 26 (oddly, he gives ISAs as an example, but they give tax relief on their returns, not income tax relief at the time of investment).  Tax reliefs are a problem for his calculation only because he works from total income, which includes an unspecified amount of tax relief.  I avoid this problem because I work from the actual tax paid, which naturally is calculated from income net of tax relief.

(Using the total income gives Murphy an additional minor problem: in the £150k-200k and £200k-£500k ranges there are some taxpayers whose net income is below £150k and who therefore avoid 'additional rate' tax at 50%.  For those who do pay tax at 50%, he assumes their average income is the average income of the whole group, but that will be a slight underestimate.)

Second, dividends.  My calculation is wrong because I implicity assumed that all taxable income is taxed at the earned income rates.  In fact dividend income is taxed at lower rates, at least for the purposes of the HMRC table.  This is important, because some high earners own their own companies and pay themselves in dividends rather than salary (I'll go into this in detail later).

Strangely, Murphy seems unaware of the different tax rates for dividends, although he is well aware of the tax avoidance potential, having used the method himself.  He mentions the dividend tax rate nowhere in his 35-page report, and says on page 6, writing about deferring tax by delaying dividends from one's own company "These profits can then be left in the company in the hope that one day either the 50% tax rate is abolished or that the company owner’s income has fallen so that the profits can be taken out as a dividend and only be taxed at 40% at most."

The tax treatment of dividends is even given in a footnote to the HMRC table: "Dividend income is charged at 10 per cent up to the basic rate limit of £35,000, 32.5 per cent above £35,000 and 42.5 per cent above £150,000."  These will be the rates used for the tax estimates in the table.

So what effect does this dividend tax rate have on the calculation, which I remind you is of how much less tax would be collected if the 50% rate were moved back to 40%, but there was no resulting elasticity effect on reported incomes?  Well, that depends exactly what you mean to calculate.  If you mean quite literally "How much of tax is paid at 50%" - the quote is from Murphy - then no tax on dividend income is paid at 50% so the answer should be reduced according to how much taxable income above £150k comes from dividends.  If you mean, as would be very reasonable, "What would be the effect of cutting top tax rates by 10% (including cutting the top dividend rate back to 32.5%)" then the division between earned income and dividend taxation has no effect on Murphy's analysis (whatever the rate, the 10% change would affect all taxable income over £150k equally - this is an advantage for Murphy's method).  It would increase my number, because I am underestimating the amount of taxable income over £150k by assuming too much tax is collected at lower levels.

If you relax the no-elasticity requirement and mean "What would be the effect of cutting the top income tax rate to 40% while leaving dividend taxes unchanged and allowing company owners to switch their income" then it's reasonable to assume that many company owners would take income in salary rather than dividends, and make the reduction in earned income tax collected much smaller - this seems to be the assumption in HMRC's table of "illustrative changes" and at least partly explains why it suggests such a small effect for a tax cut.

However, none of these is really the right question, because we are calculating notional numbers in HMRC's table of projections, not the actual projected income in tax and national insurance.  The difference arises because some of the dividend tax comes from a "dividend tax credit".  In reality, dividends from UK companies are deemed to be paid net of this notional 10%, so the rates paid in respect of dividends received are 25% above £35,000 and 36.11% above £150,000.  The dividend tax credit is in recognition of the corporation tax already paid on company profits, which ranges from 20% at £300,000 profit or less to 26% at £1.5mn profit or more.  Hence the marginal tax collected if you sell your services through a company and pay yourself in dividends is 48.89% at £300,000 per year gross and 52.72% at £1.5m gross.  If the top dividend tax rate were reduced to 32.5% those marginal tax rates would become 40% and 44.5%.  So if the true question is "What would be the effect on total tax take of cutting the top earned income and dividend tax rates by 10%", the cut in tax collected from people taking their income in dividends is about 8.5% of corporate earnings, or 11.11% of dividend income.

Incidentally, for company owners, paying yourself in dividends is always better than salary because a salary attracts tax at a marginal rate of 50% plus employee's national insurance at a marginal rate of 2% plus employer's national insurance at 13.8%, so that the marginal tax rate increases with salary asymptotically towards 57.82% of what it costs the company.*

It's interesting to look at the "income gap" in the HMRC table - the difference between the taxable income that would lead to the projected tax take if there were no allowances and all income were taxed as earned income, and the projected total income.

The 'Implied Salary' column shows the average salary that would be have to be earned with no tax reliefs to pay the amount of tax given - in the first two rows the calculation is done separately for the Higher Rate (40%) taxpayers and the Additional Rate (50%) taxpayers, and a weighted average taken.  The 'Gap' column is the difference between the Average Income and the Implied Salary.  The 'Implied Dividends' column shows what average dividend income would have to be received if all the income was taken in dividends.

I find it surprising how small the income gaps are other than for people with incomes over £1m.  The maximum tax-free pension contribution in 2011-12 is £50k, however this includes contributions made by one's employer.  The other significant sources of tax relief are Venture Capital Trusts and Enterprise Investment Schemes: in 2011-12 they will be responsible for an estimated £410mn of tax reductions between them.  Even if that were all divided between the 14,000 highest earners it would still save them only £30k of tax each, equivalent to £60k of income.  Evidently, the 'Gap' for the highest earners cannot be explained by tax reliefs alone: there is a lot of income being taken as dividends.

To sum up: Murphy's calculation is not very meaningful, as he himself tacitly acknowledges in his arbitrary downward adjustment of his estimate, but it's not in itself badly wrong.  However, he does not use the available data to best advantage, and he is remarkably imprecise about tax rates and how the tax system works.  As he advises Ryan Bourne on his site "you really do have to improve your maths".

It would be possible to mine the data more deeply to estimate what assumptions HMRC is making about the division between earned income and dividends.  But it hardly seems worth the effort, since these are just projections: rather, I'd like HMRC to publish a more detailed breakdown next time.

*Nothing in this post should be taken as tax advice.

Friday, 9 March 2012

Greek sovereign CDS: the end is nigh

The Greek Ministry of Finance announces:
Of the approximately €177 billion of bonds issued by the Republic and governed by Greek law and subject to the invitation, the Republic has received tenders for exchange and consents from holders of approximately €152 billion face amount of bonds, representing 85.8% of the outstanding face amount of these bonds.  Holders of 5.3% of the outstanding face amount of these bonds participated in the consent solicitation and opposed the proposed amendments.  The Republic has advised its official sector creditors that upon confirmation and certification by the Bank of Greece as process manager under the Greek Bondholder Act (Law 4050/2012), it intends to accept the consents received and amend the terms of all of its Greek law governed bonds, including those not tender for exchange pursuant to the invitations, in accordance with the terms of the Greek Bondholder Act...
If ISDA acts according to its previous statement, quoted here, the intended amendment of terms will cause it to declare Greek Sovereign CDS to have been triggered.

Update: ISDA has announced that "its EMEA Credit Derivatives Determinations Committee resolved unanimously that a Restructuring Credit Event has occurred with respect to The Hellenic Republic (Greece)."

Wednesday, 7 March 2012

Competition in the NHS: the evidence

I return as foreshadowed to the evidence for the effectiveness of competition in the NHS.

Carol Propper's article summarizes four papers to support its view that "the evidence gives a more positive picture".  First, regarding Choose and Book "There is no systematic evidence that the choice agenda harmed patients".  Second, "The wave of mergers that the Blair administration undertook when it first came to power...did not realise the gains that were promised before the merger. As mergers tend to reduce the potential for competition in a local market, these findings too suggests that there are benefits from competition in an NHS type system."  Third, "findings from a recent study of management in the NHS shows that better management is associated with better outcomes in NHS hospitals and that management tends to be better where hospitals compete with each other." And fourth, "The Netherlands has had a mixed system of provision for many years and has slowly introduced competition. There is no evidence that this has massively harmed equity and is thought to have led to improvements in service delivery."

Only the third of these claims is to the effect that competition in the NHS has made things better, so that's the one I'll concentrate on: it's supported by this working paper.  The paper's main aim is to establish that competition between NHS hospitals causes them to have better management.  It creates measures of competition, management quality, and clinical quality, and looks for associations between them.  To establish causality, it uses an Instrumental Variable.

I'll attempt a handwaving explanation of the method instrumental variables for any reader who happens not to be an econometrician, as I am not.  The problem it addresses is that whereas it's often possible to show some correlation between two variables X and Y, that does not imply that X causes Y, as one might want to demonstrate.  Correlations can arise instead because Y causes X, or because factor Z causes both X and Y, or because of coincidental trends in X and Y.  The approach is to identify an instrumental variable IV which can be shown by fundamental arguments (i) to affect X and (ii) to be correlated with Y only through its effect on X.  For example, suppose one wanted to measure how changes in the price of coffee affect coffee sales in England.  The problem is that if there's an independent rise in demand for coffee, the price will tend to go up.  One wouldn't want to interpret that increase in price as causing the increase in sales.  The solution here is to find an instrumental variable affecting coffee prices: for example, one might identify a measure of the suitability of the weather in various coffee-growing regions, with an appropriate time lag.  One would expect this measure to be negatively correlated to the price of coffee, and it might be positively correlated to coffee sales.  There are then some not very difficult statistical methods which can be used to derive an estimate of the sensitivity of coffee sales to prices.

Back to the paper about competition in the NHS: the authors find correlations between their three measures, and turn to the method of Instrumental Variables to try to demonstrate that competition is the causal factor.
Identifying the causal effect of competition is challenging, but the fact that exit and entry are strongly influenced by politics in a publicly run healthcare system, like the UK National Health Service (NHS), offers a potential instrumental variable - the degree of political competition.
It supports this theory of political competition by observing that
When Labour’s winning margin is small (under 5%) there are about 10% more hospitals than when it or the opposition parties (Conservatives and Liberal Democrats) have a large majority.
Figure 1 on the paper is a histogram of hospital density by English parliamentary constituency against Labour majority in the 1997 general election, in which Labour under Tony Blair gained a landslide victory.  It shows that the highest density is in constituencies with small Labour majorities: the authors say this validates their theory that the governing party will tend to open new hospitals and not close existing hospitals in the constituencies where it feels vulnerable.  (The title of the histogram is somewhat misleading: hospital density is defined here as the number of qualifying hospitals within 30km of the centroid of the constituency. The number is quoted "per million population": I can't tell exactly how this scaling to population has been done.)

I note that the second highest density is in constituencies with small majorities for another party.  How does that fit the theory?  Surely the Labour government after the 1997 election wasn't much influenced by the hope of winning a still larger majority next time.  I have an alternative explanation: typically inner-city constituencies return Labour MPs, and rural constituencies return Conservative MPs.  Marginal constituencies tend to be in the transition zone between city and countryside.  Compare that to the pattern of hospital building in the 20th century, especially in the 60s and 70s.  Hospitals were built or extended on the outskirts of cities, where the space was available.  So it's a fair guess that one will tend to find more hospitals in and around marginal constituencies, even if political interference has been negligible.

Incidentally, "When Labour is not the winning party, the margin [plotted in the histogram] is the negative of the difference between the winning party (usually Conservative) and the next closest party".  Why the margin between Conservatives and Liberal Democrats should be relevant in their theory the authors do not say.  It would make more sense for them to use the margin by which Labour trailed the winning party.

If they wanted a fair test of their theory, the authors would look at changes in hospital densities after 1997, comparing the numbers particularly between constituencies with small Labour majorities and the (presumably quite similar) constitutencies where Labour had finished close behind the winning party.

Having confirmed their theory, the authors tell us that
Using the share of government-controlled (Labour) marginal political constituencies as an instrumental variable for hospital numbers we find a significant causal impact of greater local competition on hospital management practices.  We are careful to condition on a wide range of confounding influences to ensure that our results are not driven by other factors (e.g. financial resources, different local demographics, the severity of patients treated at the hospital, etc.).
They are now taking as their Instrumental Variable the proportion of the political constituencies within 30km of the hospital which were Labour-held marginals.  The theory is that a hospital in a marginal area is likely to have other hospitals near it, because the government will be reluctant to close hospitals there, and keen to open them.

So is this a suitable IV according to the two criteria I listed?  First, how strongly can it predict hospital density?  There's a list of  winning margins here: I count 18 English Labour marginals according to the criteria in the paper, out of 529 constituencies.  There are large parts of the country with no such constituencies; the statistical test will be ignoring most of the data.  So this IV performs poorly on the first criterion: it can account only weakly for variations in hospital density.  Second, is there good reason to think that it can affect management and clinical performance measures only through its effect on hospital competition?  No, certainly not.  Marginal constituencies tend to have particular geographical characteristics which may well affect their ability to recruit staff, among other things.  And if it's true that politicians care a lot about hospitals in those constituencies, they will be all too likely to intervene in ways other than just changing the number of them.  For example they might encourage their favourite managers to work for such hospitals, or direct resources to improve key statistics.  So the IV fails to satisfy the second criterion also.

Beyond the discussion of why they think it should be related to hospital density, the authors give no consideration to the suitability of their choice of Instrumental Variable for the statistical analysis they present, and they make no mention of the scarcity of Labour marginal constituencies.   (To be fair, this is only a working paper.)  The fact is that this instrumental variable is wholly unsuitable for statistical purposes: no valid conclusions about causality can be drawn with it.

That makes the rest of the paper moot.  But I can't resist saying a few words about its measure of management quality.  The authors include a resigned note about responses to their questionnaire "it was harder to obtain interviews with the physicians than managers (80% of the respondents were managers)".  Quite so.  The authors tell us that these measures correlate well to firm performance, but I suspect they translate less well to hospitals, where the important work is done by technical experts whose response to polysyllabic management-speak is likely to be expressed in words of one syllable.

Monday, 5 March 2012

On the benefits of competition in healthcare

I've borrowed the title from this post, which I reached  via Chris Dillow's "top blogging" list.  The post is enthusastic about the benefits of competition to the NHS.  But first, some background thoughts:

Few in the 21st century would deny that competitive markets are better at producing stuff people want than is state monopoly.  Ardent free-marketers assert that the same principle must apply to healthcare, but the logic is unclear to me.  For competition to keep prices down, consumers have to care how much they spend.  For competition to make products better, consumers have to be able to tell how good competing products are.  These factors may be present in healthcare choices, but that's far from guaranteed.  Competition can be expected to lead to better and cheaper refractive eye surgery.  It's helpful in controlling prices for breast augmentation, though regulation of the quality of the implants may be necessary.  But it's unlikely to do much for the emergency treatment of traumatic fractures.

The empirical evidence tends to confirm the difficulties.  Healthcare in the USA is competitive but egregiously expensive, and the high price does not lead to outstanding performance.  There are many reasons for this, but an important factor seems to be that consumers are spending little of their own money: insurance policies now include co-payments, but they tend to be fixed amounts that create little price competition between providers. And inflation in private medical insurance worldwide is well above general inflation, by comfortably more than the 2.5% pick-up sometimes quoted as steady state funding for the NHS.

On the other hand, Singapore has an effective healthcare system based on individual insurance, backed up by government price controls.  Family-level pooling gives patients motivation to control costs without obliging them to hold personal insurance for the whole liability.  This would be "a very difficult system to replicate".

Successive UK governments have introduced elements of competition into the NHS in the hope of restraining costs and raising quality.  My personal observations make me sceptical about this, but it's as well to look at what data is available.  And the article I cited at the start of this note claims to have evidence that competition is working its magic.  I'll examine some of the evidence in my next post on this.

Inexpert tax experts

Richard Murphy, the "tax expert", is strongly in favour of retaining the 50% top income tax rate in the UK:
About 300,000 people will be affected by this tax in HMRC’s estimate. They have taxable income after allowances and reliefs of £150,000 a year. They represent about 1.0% of all taxpayers.

They’re expected to have total taxable income between them of about £47 billion. So the tax - which is an extra 10% over and above the 40% rate previously applying should raise nearly £5 billion a year. It may, because of the disallowance of personal allowances and pension contributions for this group for which we have no real impact data as yet, be higher than that in my opinion – closer to £6 billion in fact, but I stress that’s an estimate.

This is higher than HMRC have estimated – they’ve never gone above £3 billion. It is very obviously radically different from the claims made by opponents that this tax will cost the government money...
He doesn't explain where he gets "nearly £5 billion" from, but the way he presents it makes it look very much  as if he's taking 10% of £47 billion.

Ryan Bourne of the Centre for Policy Studies seizes on this:
I accessed HMRC’s income tax liabilities by taxpayer marginal rate table for 2011-12. Sure enough, it says that additional rate taxpayers (the top 1% earning over £150,000) are liable for a total of £47 billion in tax (28% of total income tax revenues). Therefore it seems that Richard has just assumed that lowering the tax rate from 50% to 40% would be equivalent to reducing their tax liability by 10 percentage points, or £4.7 billion.

This is not how our tax system works. In fact, people earning over £150k don’t pay 50% of their income in tax. The 50% rate means that any income you earn over £150,000 is taxed at 50% - it’s what economists call a marginal rate...

...This means that Richard has overestimated the revenue that the 50p rate brings in, because it doesn’t apply to the first £150,000 of any one of these people’s income. In other words, all income revenue tax paid by those in the 50% rate band below £150,000 is completely unaffected by the change in rate. Given that there are 308,000 additional rate payers and each pays £53,000 in tax before reaching the £150,000 threshold where the 50% rate kicks in, £16.3 billion of the revenues collected from the richest 1% have nothing to do with the 50% rate.

So what would happen if the rate were lowered to 50% to 40% in terms of the remaining revenues actually collected from the 50% tax rate bit? Helpfully, HMRC provides a ready reckoner which estimates this very thing. It estimates that for every 1p drop in the rate, revenue would drop by £70m this year and £120m next year. So, dropping the rate by 10 percentage points, or 10p, would cost between £700m and £1.2 billion – even less than the Treasury’s own predictions. This is likely to take into account behavioural changes: if more people leave the country or find legal ways to avoid paying the 50% rate then revenue will not increase from a higher rate on a straight line basis.
Bourne is right about the £16.3bn (you can read the £53,000 he mentions off this chart).  But he's quite wrong in taking 10% of what's left.  The £47bn is a tax liability, not a taxable income.  So that minus £16.3bn is the tax collected by the 50% rate.  If it were reduced to 40%, then others things being equal a fifth less would be collected: the difference would be £6.1bn.

It's intriguing that Murphy has guessed something very close to that number.  I wonder whether someone who does understand this not very difficult calculation has told him the right number, and he's tried and failed to reproduce it.

£6.1bn is of course vastly more than what Bourne comes up with using Treasury estimates  of the effect of  changing the rate.  The Treasury figure is their best guess, taking into consideration that cutting the top rate will considerably increase taxable incomes of more than £150,000.  These effects are notoriously difficult to estimate.

Murphy reports triumphantly that the number he gets is much more than the estimates given by opponents of the tax.  He goes on to predict that there will be very little elasticity: he is confident that he knows better than the Treasury how people react to changes in income tax rates.

I'm in favour of giving it a couple of years and finding out whose predictions are closer to the truth.

Update 6th March:
Murphy has published a new post in which he sort-of denies making the error Bourne accuses him of:
...if I’d done what [Bourne had] suggested I’d have said that the extra tax would be 25% extra on the £47 billion – which is the proportionate increase on the tax yield of £47 billion that would have been due if all the income that had previously been due at the same fixed 40% marginal rate had now been due at 50%. That’s because 10% is 25% of 40%. And so the extra tax would have actually been, if I’d committed such an error, a whopping £11.75 billion. In that context it’s clear that £4.7 billion more than adequately compensates for the fact that not all the tax on anyone’s income is due at the 50% rate...
...As you’ll see tomorrow my actual estimate of potential tax yield is higher than £4.7 billion – I just used that as a headline last week whilst waiting for my full report to come out...
But the way he phrases all this it does seem that 10% of £47 billion is exactly the "headline" calculation he did.  And if he had been aware of the correct calculation, he wouldn't now be writing "10% is 25% of 40%" when he should be saying "10% is 20% of 50%".

However, Bourne is more credulous than I am, and has apologized and withdrawn his post.

Friday, 2 March 2012

Boosting Business and Encouraging Entrepreneurs

An alliance of rich people has written to the Telegraph urging the Chancellor to cut the top income-tax rate so as to "boost business and encourage entrepreneurs".    I'm puzzled by this: there's no need for entrepreneurs to pay income tax on money they invest in new businesses.  Do they mean that higher income taxes cause them to take more money out of their businesses so as to maintain their net income?

Meanwhile, other opponents of the 50p top rate warn us that it may not raise any extra money anyway, because it will put top-rate payers off earning the stuff.  They might be right, but if so, it tells us that the rich guys are not that interested in maintaining their net incomes, otherwise an increase in the top rate would make them work even harder.

So one of those arguments could be right, but not both.

A more cautious analysis would suggest that much of the reduction in top-rate take is likely to be temporary: it's much easier for high earners to move their income forward or back by one year than by two years or more.  That would suggest that in all fairness we should persist with the 50p rate for long enough that everyone who ought to pay it has to pay it.

Thursday, 1 March 2012

Copyright: a proposal

As previously discussed, property rights for non-rivalrous goods are not the same as for tangible property, because they're not needed as a rationing mechanism to allocate finite resources.

However, we want new works to be created, and a good way to encourage people to do things is to pay them for it.  So we should keep copyright in some form.  But whereas copyright can enrich us by encouraging the creation of new works, it impoverishes us by restricting access to existing works.  We need to strike a balance.  The current Berne Convention stipulation of 50 years after the author's death is far too long - according to the EU it was intended to benefit two generations of the author's descendants.  The extension to 70 years after the author's death in the EU and the USA is supposed to allow for longer lifespans.  But it's fantastically implausible that a prospective author would be deterred from producing creative work by the consideration that her grandchildren might not receive royalties from it.

I suggest that we retain copyright in its current form, with the exception that we restrict it to five years from first publication.  That should be sufficient in most cases for the author to receive a fair return, but we should allow extensions year by year if the last year's sales of a work are the highest yet, so as to accommodate works that take some time to become popular.

This paper attempts a theoretical analysis of the optimum (welfare maximizing) copyright term, and comes up with fifteen years. Whereas this one, which I find more convincing, thinks two years is about right (reportedly the authors think their model unrealistic, and actually believe that copyright should not exist at all).  Before we adopt my proposal worldwide we should probably explore the optimum term more thoroughly: we might decide to adopt different terms for different classes of work.

I suggest that we add an additional right to protect one's reputation as the author of a copyrightable work, to apply during one's lifetime after the copyright period has expired.  This would mean that anyone using the work in public would be required to state whether it was used with the author's permission.  The author  would have the right to waive this requirement for some or all users.

Any objections?