Bring Me My Pot Of Gold

We've got stacks of these

The fundamental reason we have to cut the welfare bill is because we can't afford it. At 16% of GDP and growing, we simply have to get a grip. And of course, the decisions are difficult, and the consequences for some individuals can seem harsh. But we just can't go on as we are.

Or can we?

Over the last week we've heard a lot about pots of gold that could pay our welfare bill without having to inflict cuts on the poor. Here are three of them, all heavily promoted by our friends at the BBC:

1. If the government would just swallow its Plan A pride and get people back to Plan B work, the welfare bill would fall and there'd be loads more tax revenue coming in. The problem would solve itself.
2. We could reverse the tax cut for millionaires, using the extra revenue to safeguard benefits.
3. We could clamp down on corporate tax avoidance and get tens of billions more revenue. 

Pot One - traditional Keynesian pump-priming - is a seductive idea, but as Andrew Lilico points out today, with the government stuck on a £120bn pa deficit it doesn't offer a credible way forward. In effect, we've already been trying Plan B ever since the Crash and it hasn't worked. 

As for the idea that increases in public spending can be self-funding through their impact on GDP and tax revenues, that's akin to plans for a perpetual motion machine. Estimates of the actual impact vary, but the Office for Budget Responsibility reckons that an extra Pound of public spending boosts GDP by between 60 and 100 pence, depending on the type of spending (capital spending works much better than welfare spending). But since the amount that comes back as tax revenue will be less - perhaps 20 to 40 pence - the government's deficit is left 60 to 80 pence higher.  There are no magic pots of gold here.

Pot Two sounds even more attractive to most of us - reverse the millionaire's tax cut and pay the welfare bill without whacking the rest of us on incomes below £150k. 

Again though, the numbers don't stack up. According to the official HMRC analysis, increasing the top rate of tax from 40% to 50% raised much less than the £2.5bn pa originally promised by Labour. HMRC says:

"The conclusion that can be drawn... is that the underlying yield from the additional rate is much lower than originally forecast (yielding around £1 billion or less), and that it is quite possible that it could be negative. This conclusion is supported by wider academic literature which generally suggests a greater behavioural response than was included in the Budget 2009 and March Budget 2010 estimates. Evidence from the U.S. suggests the behavioural responses could be even higher, with an even lower yield."

The problem is that golden geese no longer hang around waiting to be plucked: faced with a punitive hike in tax rates they find ways of reducing their taxable income, possibly flying away entirely. Between 2009-10 and 2010-11, faced with a tax hike from 40% to 50%, they reduced their incomes by 25%:

Moreover, the longer-term damage to the economy is likely to be even greater, as entrepreneurial types leave for sunnier, lower tax climes. And as the economy suffers, revenue from other taxes also sags. HMRC says:

"High tax rates in the UK make its tax system less competitive and make it a less attractive place to start, finance and grow a business. The longer the additional rate remains in place the more people are likely to consider it a permanent feature of the UK tax system and the more damaging it would be for competitiveness. This suggests the negative impact on GDP may increase over time, and therefore the direct yield (and revenues from other tax bases) might fall over time toward or beyond zero."

In today's globalised high mobility economy, higher tax rates for millionaires are very far from being our pot of gold: in fact, they can easily turn out to be the exact opposite.

Pot Three - clamping down on tax avoidance by the likes of Starbucks - is widely trailed, and also sounds painlessly attractive to the rest of us. Because according to some estimates, the tax gap between what big companies ought to pay according to the spirit of the law, and what they actually pay, runs into tens of billions annually.

But once again, the reality is somewhat different. According again to HMRC, the tax gap for companies is only around £4bn pa, which while worth having, is nowhere even close to the £200bn plus we spend on welfare. Moreover, tax avoidance is an exceptionally grey area, and one man's tax avoidance is another's perfectly legitimate protection of shareholder interests.

And that pesky globalised economy makes it virtually impossible for one country acting alone to do much about it. Indeed, over the long-term governments may well have to phase out their taxation of multinational companies altogether. They may have to rely on taxing company earnings only when they distributed back to their own resident shareholders (which is how it was done originally back in Victorian times).

So three pots of gold that turn out to contain little but wishful thinking.

The only way of making welfare affordable is to cut it. Or more specifically, to tighten up on eligibility and to focus what cash we can afford on those who need it most. The painful choices are unavoidable.

PS Going back to that global savings glut and the role of those high saving Chinese, I was fascinated to read this account in the English version of the People's Daily. Not so much for the story itself, but for the accompanying list of the PD's most popular articles. Nothing to do with savings, or lack of welfare provision, or say, the shenanigans next-door in North Korea. No, the most popular article right now - complete with pic - is "Bogus sexy cop charged":

"A model who impersonated a police officer, posting sexy photos of herself online, has been given a suspended jail sentence at Fengtai district court for cheating and bluffing, which damaged the image of government officials, the Beijing Times reported Tuesday. The woman, 23, surnamed Wang, posted sexy photos on her microblog in July, including one in which she was pulling on black stockings while wearing a police shirt. She also wrote that as a policewoman, she has so much pressure because she has to dine with government officials every day."

Do they have April Fools Day in China? What would the Great Helmsman have said? What isn't clear is whether the article is meant as a warning to other microblogging bogus sexy cops, or whether the PD thinks those government officials need to chill. Of course, our own cops are perfectly capable of cheating and bluffing all alone without any help from bogus ones - as we've seen in the Mitchell case.