A Level Economics 59: Taxes and Subsidies

Different Varieties of Taxes and Subsidies:

Taxes:

1. Pigouvian Tax: A Pigouvian tax is designed to correct market failures related to negative externalities. It is imposed on activities that generate harmful effects on third parties, such as pollution or congestion. By internalizing the external costs, the tax aims to align private costs with social costs, discouraging the harmful activity.

2. Carbon Tax: A specific type of Pigouvian tax, levied on greenhouse gas emissions, to address climate change. Companies emitting carbon dioxide or its equivalent pay the tax, incentivizing them to reduce emissions and invest in cleaner technologies.

3. Tobacco Tax: Imposed on tobacco products to reduce smoking and the associated negative health externalities. Higher taxes discourage consumption, especially among vulnerable populations like youth, and fund public health initiatives.

Subsidies:

1. Production Subsidy: Provided to firms engaging in activities that generate positive externalities. The subsidy reduces their costs, encouraging increased production of socially beneficial goods or services.

2. Research and Development (R&D) Subsidy: Given to firms to promote innovation and technological advancement. By lowering the costs of R&D, firms are encouraged to invest in research for the development of new products and technologies with positive externalities.

3. Education Subsidy: Designed to support education and human capital development, leading to positive externalities like a skilled and educated workforce. Subsidizing education can increase access to quality education and enhance labor productivity.

2. Using Taxes and Subsidies to Correct Market Failures:

Correcting Negative Externalities:

• Tax: Governments can impose Pigouvian taxes, such as carbon taxes, on activities causing negative externalities like carbon emissions. The tax increases the cost of carbon-intensive activities, leading to reduced emissions and a shift towards cleaner alternatives.
• Subsidy: To incentivize the use of renewable energy and reduce reliance on fossil fuels, governments can provide subsidies to renewable energy producers. The subsidy lowers production costs, making renewable energy more competitive and reducing the negative externality of greenhouse gas emissions.

Promoting Positive Externalities:

• Tax: There are no direct tax interventions to promote positive externalities, as taxes are used primarily to address negative externalities.
• Subsidy: For activities generating positive externalities, governments can provide production subsidies. For example, subsidizing organic farming can encourage environmentally friendly agricultural practices and the preservation of biodiversity.

Providing Public Goods:

• Tax: Governments can finance the provision of public goods like public parks and national defense through taxation. Individuals contribute through taxes, and public goods are made available to everyone without exclusion.
• Subsidy: There are no direct subsidy interventions for providing public goods, as they are usually financed through taxation.

Addressing Monopolies and Market Power:

• Tax: Governments may impose taxes on monopolistic industries to prevent excessive market power and prevent the abuse of consumers.
• Subsidy: There are no direct subsidy interventions to address monopolies, as subsidies are generally aimed at promoting positive externalities.

In conclusion, taxes and subsidies are valuable tools that governments can use to correct market failures associated with externalities. Taxes help internalize negative externalities, while subsidies incentivize activities generating positive externalities. Through strategic use of these interventions, governments can promote a more efficient allocation of resources and address market failures to improve overall economic welfare.

 

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Ideological Positions and Economic History

 

My response to Shekhar Gupta's video

Dear Mr. Gupta

I believe your thesis on economic history is flawed when you argue that Japan, Korea, Taiwan and Singapore have grown because of economic freedoms i.e. I presume you mean free market practices. I have often heard you say that India too should follow free market practices to achieve similar heights. In the above process the elephant in the room i.e. how China rose with state intervention, has also been ignored.

Kindly permit me to state a few historical facts extracted from 'Bad Samaritans The Guilty Secrets of Rich Nations...' by Ha Joon Chang

1.  When Robert Walpole became the British Prime Minister in 1721 he launched a Swadeshi* policy aimed to protect British manufacturing industries from foreign competition, subsidise them and encourage them to export. Tariffs on imported foreign manufactured goods were significantly raised while tariffs on raw materials were lowered. Regulation was introduced to control the quality of manufactured goods so that unscrupulous manufacturers could not damage the reputation of British products in foreign markets. Walpole’s protectionist policies remained in place for the next century, helping British manufacturing industries catch up with and then finally forge ahead of the counterparts on the Continent.By the end of the Napoleonic wars in 1815 British manufacturers were firmly established as the most efficient in the world and it was then that they started campaigning for free trade.

2. The US too followed similar protectionist policies, espoused by Alexander Hamilton, which included protective tariffs, import bans, subsidies, export ban on key raw materials, financial aid...until the end of the Second World War (WWII). It was only after WWII, with its industrial supremacy unchallenged, that the US started championing the cause of free trade. Even when it shifted to freer trade, the US government promoted key industries by another means; namely public funding of Research and Development (R&D). Without government funding for R&D the US  would not have been able to maintain its technological lead over the rest of the world on key industries like computers, semiconductors, life sciences, the internet and aerospace.

3. In Japan the famous MITI (Ministry of International Trade and Industry) orchestrated an industrial development programme that has now become a legend. After WWII, imports were tightly controlled through government control of foreign exchange. Exports were promoted in order to maximize the supply of foreign currency needed to buy up better technology. This involved direct and indirect export subsidies as well as information and marketing help from JETRO the state’s trading agency.

4. Even Korea has not been an exception to this pattern. The Korean miracle was the result of a clever and pragmatic mixture of market incentives and state direction. The Korean government did not have blind faith in the free market either. While it took markets seriously, the Korean strategy recognized that they often need to be corrected through policy intervention.

5. Singapore has had free trade and relied heavily on foreign investment, but even so, it does not conform in other respects to the neo-liberal ideal. It used considerable subsidies to MNCs in industries it considered strategic. It also has one of the largest state owned enterprises which supplies housing and almost all land is owned by the government.

To conclude, I feel that Mr. Gupta’s advocacy of free markets is based on a fundamentally defective understanding of the forces driving globalisation and a distortion of history to fit the theory. Free markets and trade was often imposed on rather than chosen by weaker countries. Virtually all successful economies, developed and developing, got where they are through selective strategic integration with the world economy rather than unconditional  global integration.

Regards

Girish Menon

* Swadeshi  is a conjunction of two Sanskrit words: swa ("self" or "own") and desh ("country"). Swadeshi is an adjective which means "of one's own country".

'Heads we win, tails you lose': how America's rich have turned pandemic into profit

As 26 million Americans lose their jobs, the billionaire class has added $308bn to its wealth writes Dominic Rushe and Mona Chalabi in The Guardian


 

Jeff Bezos has seen his wealth increase from $105bn to $130bn. Photograph: Mona Chalabi


Never let a good crisis go to waste: as the coronavirus pandemic sweeps the world, America’s 1% have taken profitable advantage of the old saying.

Some of the richest people in the US have been at the front of the queue as the government has handed out trillions of dollars to prop up an economy it shuttered amid the coronavirus pandemic. At the same time, the billionaire class has added $308bn to its wealth in four weeks - even as a record 26 million people lost their jobs.

According to a new report from the Institute for Policy Studies, a progressive thinktank, between 18 March and 22 April the wealth of America’s plutocrats grew 10.5%. After the last recession, it took over two years for total billionaire wealth to get back to the levels they enjoyed in 2007.

Eight of those billionaires have seen their net worth surge by over $1bn each, including the Amazon boss, Jeff Bezos, and his ex-wife MacKenzie Bezos; Eric Yuan, founder of Zoom; the former Microsoft chief Steve Ballmer; and Elon Musk, the Tesla and SpaceX technocrat.

The billionaire bonanza comes as a flotilla of big businesses, millionaires and billionaires sail through loopholes in a $349bn bailout meant to save hard-hit small businesses. About 150 public companies managed to bag more than $600m in forgivable loans before the funds ran out. Among them was Shake Shack, a company with 6,000 employees valued at $2bn. It has since given the cash back but others have not.

Fisher Island, a members-only location off the coast of Miami where the average income of residents is $2.2m and the beaches are made from imported Bahamian sand, has received $2m in aid.

Its residents seemed to be doing fine even before the bailout. This month, the island purchased thousands of rapid Covid-19 blood test kits for all residents and workers. The rest of Florida is struggling. About 1% of Florida’s population has been tested for the coronavirus, behind the national figure of 4%. The state is also in the midst of an unemployment claims crisis, with its underfunded benefits system unable to cope with the volume of people filing.

The banks that were the largest recipients of bailout cash in the last recession have also done well, raking in $10bn in fees from the government loans, according to an analysis by National Public Radio.

“Heads we win, tails you lose,” said Chuck Collins, director of the program on inequality and the common good at the Institute for Policy Studies and co-author of the new report.

Collins said the pandemic had further exposed fault lines in the US body politic that have been widening the gap between the really rich and the rest over decades.

“The rules of the economy have been tipped in favor of asset owners against everyone else,” said Collins.

By 2016 – seven years after the end of the last recession – the bottom 90% of households in the US had still not recovered from the last downturn while the top 10% had more wealth than they had in 2007.

Throughout the recovery, stock market gains disproportionately favored the wealthy. The top 1% of households own nearly 38% of all stock, according to research by the New York University economist Edward Wolff. Even before the coronavirus hit, homeownership in the US – a traditional source of wealth growth – was well below its 2004 peak.

Nor did Americans earn more. Wage growth remained sluggish during the decade-long record-breaking growth in the jobs market that came after the last recession.

For black and Latin Americans, the situation is worse. The black-white wage gaps are larger today than they were in 1979.

Meanwhile, billionaires have been unable to put a well-heeled foot wrong. Billionaire wealth soared 1,130% in 2020 dollars between 1990 and 2020, according to the Institute for Policy Studies. That increase is more than 200 times greater than the 5.37% growth of median wealth in the US over this same period. And the tax obligations of America’s billionaires, measured as a percentage of their wealth, decreased 79% between 1980 and 2018.

So when the pandemic struck, those at the apex of the wealth pyramid were better positioned than ever to take advantage of the chaos. The rest, not so much.

Collins has been studying income inequality for 25 years and has seen the really rich win victory after victory. But even he was surprised by how quickly America’s billionaires have turned pandemic into profit. “I still get shocked,” he said.

Never mind ‘tax raids’, Labour – just abolish private education

As drivers of inequality, private schools are at the heart of Britain’s problems. Labour must be bold and radical on this writes Owen Jones in The Guardian

 

Labour leader Jeremy Corbyn at the TUC Congress in Brighton. Photograph: Ben Stansall/AFP/Getty Images


The British class system is an organised racket. It concentrates wealth and power in the hands of the few, while 14 million Britons languish in poverty.

If you are dim but have rich parents, a life of comfort, affluence and power is almost inevitable – while the bright but poor are systematically robbed of their potential. The well-to-do are all but guaranteed places at the top table of the media, law, politics, medicine, military, civil service and arts. As inequality grows, so too does the stranglehold of the rich over democracy. The wealthiest 1,000 can double their fortunes in the aftermath of financial calamity, while workers suffer the worst squeeze in wages since the Napoleonic wars. State support is lavished on rich vested interests – such as the banks responsible for Britain’s economic turmoil – but stripped from disabled and low-paid people. The powerful have less stressful lives, and the prosperous are healthier, expecting to live a decade longer than those living in the most deprived areas.

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Unless this rotten system is abolished, Britain will never be free of social and political turmoil. It is therefore welcome – overdue, in fact – to read the Daily Telegraph’s horrified front-page story: “Corbyn tax raid on private schools”.

The segregation of children by the bank balances of their parents is integral to the class system, and the Labour Against Private Schools group has been leading an energetic campaign to shift the party’s position. The party is looking at scrapping the tax subsidies enjoyed by private education, which are de facto public subsidies for class privilege: moves such as ending VAT exemptions for school fees, as well as making private schools pay the rates other businesses are expected to. If the class system has an unofficial motto, it is “one rule for us, and one rule for everybody else”. Private schools encapsulate that, and forcing these gilded institutions to stand on their own two feet should be a bare minimum.

More radically, Labour is debating whether to commit to abolishing private education. This is exactly what the party should do, even if it is via the “slow and painless euthanasia” advocated by Robert Verkaik, the author of Posh Boys: How English Public Schools Ruin Britain. Compelling private schools to apply by the same VAT and business rate rules as others will starve them of funds, forcing many of them out of business.

Private education is, in part, a con: past OECD research has suggested that there is not “much of a performance difference” between state and private schools when socio-economic background is factored in. In other words, children from richer backgrounds – because the odds are stacked in their favour from their very conception – tend to do well, whichever school they’re sent to. However unpalatable it is for some to hear it, many well-to-do parents send their offspring to private schools because they fear them mixing with the children of the poor. Private schools do confer other advantages, of course: whether it be networks, or a sense of confidence that can shade into a poisonous sense of social superiority.

Mixing together is good for children from different backgrounds: the evidence suggests that the “cultural capital” of pupils with more privileged, university-educated parents rubs off on poorer peers without their own academic progress suffering. Such mixing creates more well-rounded human beings, breaking down social barriers. If sharp-elbowed parents are no longer able to buy themselves out of state education, they are incentivised to improve their local schools. 

Look at Finland: it has almost no private or grammar schools, and instead provides a high-quality local state school for every pupil, and its education system is among the best performing on Earth. It shows why Labour should be more radical still: not least committing to abolishing grammar schools, which take in far fewer pupils who are eligible for free school meals.

Other radical measures are necessary too. Poverty damages the educational potential of children, whether through stress or poor diet, while overcrowded, poor-quality housing has the same impact too. Gaps in vocabulary open up an early age, underlining the need for early intervention. The educational expert Melissa Benn recommends that, rather than emulating the often narrow curriculums of private schools, there should be a move by state schools away from exam results: a wrap-around qualification could include a personal project, community work and a broader array of subjects.

In the coming election, Labour has to be more radical and ambitious than it was 2017. At the very core of its new manifesto must be a determination to overcome a class system that is a ceaseless engine of misery, insecurity and injustice.

Britain is a playground for the rich, but this is not a fact of life – and a commitment to ending private education will send a strong message that time has finally been called on a rotten class system.

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Have cake and eat it too - How to beat Brexit, steal best state school pupils, get paid and retain tax charitable status

Anon




On 9 December I was perplexed to read The Telegraph headline “Private schools plan to offer 10,000 free places to children from low-income backgrounds”. 

Immediately I thought, ‘This is a good idea’

A few seconds later, I remembered that we are in the era of post truth politics. So, I thought let me look behind the spin and see what the proposal actually means.

Many of the UK’s fees collecting private schools are charities according to their tax status. This status has been challenged by successive governments who have found few instances of charitable work and more instances of price rigging. These schools also face the new prospect of Brexit and fewer fee paying EU students on their rolls. 

To overcome this threat, The Independent Schools Council (ISC) has proposed to teach 10,000 state school students if the government agrees to pay them £5,550 per student. This will enable the private schools to demonstrate their charitable work to retain their charitable tax status and will assure them with a steady supply of students to replace the EU nationals who may prefer to go elsewhere post Brexit.

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In my view this proposal reminds me of the PPP (private public partnership) and PFI (Private Finance Initiative) proposals which have bled the state’s coffers and unduly benefited private firms. Here are some ways the state will be worse off by accepting the ISC initiative. 

No further need to do charity work: Any private school charity has to demonstrate actual charitable work in order to enjoy its tax status as a charity. The ISC hopes this proposal will enable them to overcome criticism of not doing sufficient charitable work.

Raiding state schools of better able students: State schools already feel beleaguered with budget cuts affecting their ability to teach students. This proposal will result in a further exodus of better able students who will be cherry picked by the private schools.

I feel there is no need to accept the ISC proposals. ISC members already enjoy a subsidy in the form of a charitable tax status despite not complying with the requirements of a charity.

Secondly, the above proposal if accepted will resemble the Nissan deal where the state intervenes with a sweetheart deal to once again protect privileged profit making non charitable ‘charities’.

But, I must confess the ISC have adapted well to the era of post truth politics by presenting a self preserving proposal as a charitable act. Is it a case of eating cake and having it too?

Why you’re wrong to think that your house will finance your retirement

Treating houses as a financial instrument leads to an undiversified investment portfolio, with a large proportion of wealth concentrated in a single asset

Satyajit Das in The Independent


According to English writer Virginia Woolf, a woman in Victorian England needed money and a room of her own in order to write. In the modern world, housing itself has become a work of fiction.
A house provides shelter and a dwelling place. But increasingly this simple consumption good has been converted into a financial asset or investment as well as instrument of policy.

Governments subsidise home ownership in different ways. They may provide tax benefits such as tax deductions for mortgage-interest payments or lower taxes on capital gains from the sale of a residence. Common concessions include lower property taxes or stamp duty of property transfers as well as direct assistance for the purchase of homes. It also includes housing finance on preferential terms.

The subsidies mean that where they can, people buy multiple homes. The affluent own holiday homes which stay empty for much of the year, while less well-off are made to make do with sub-standard accommodation or, in the case of the poor, no homes at all.

Houses become larger. Virginia Woolf would have recognised these MacMansions: “Those comfortably padded lunatic asylums which are known, euphemistically, as the stately homes of England.”
Over-investment in housing is economically inefficient. Unlike businesses, houses once constructed generate limited income, profits, employment or investment.

Excessive housing investment also creates an inflexible labour force, reducing the mobility of workers. The ability to follow employment opportunities is restricted by fluctuations in house prices, the lack of liquidity of the housing market and high transaction costs (buying and selling can cost 5-10 per cent of the value of the house). It also limits wage flexibility, as workers are constrained by their mortgage commitments.

The replacement of company or government-funded retirement with self-funded arrangements means that houses have become a means for wealth creation. As homeowners pay off their mortgages, their home becomes a major financial asset. But residential property produces no income even where they increase in value. Maintenance costs, utility bills and property taxes mean that houses require rather than provide cash.

Homeowners must generate income by borrowing against their home to finance consumption and eventually finance retirement. The strategy requires realising the home equity (the difference between the value of the house and the mortgage debt outstanding) by either borrowing or selling the property, moving into a smaller house or a rental.

Treating houses as a financial instrument leads to an undiversified investment portfolio, with a large proportion of wealth concentrated in a single asset – the home, which does not produce income.

Investors also buy houses and apartments with borrowed money to rent out. The income from property is rarely higher than that on other income-producing investments. Where borrowed money is used, the rent may not fully cover interest and other outgoings. There is speculative reliance on ever-increasing property prices to boost returns or repay the debt used to finance the property leaving a profit for the buyer.

Reliance on houses creates exposure to volatile house prices. As the global financial crisis illustrated, prices can be affected by a confluence of adverse events – economic cycles, the availability of credit and demographics where large cohorts may retire at the same time. Price fluctuations are exacerbated by the illiquidity of the asset.

Many economies now rely excessively on the housing market. Housing investment sustains economic growth. Unlike many industries, it is largely domestic, driving employment, income and economic activity. In The Age of Turbulence, Alan Greenspan approvingly quotes economics columnist Robert Samuelson’s assessment of his policies in the early 2000s: “The housing boom saved the economy… Americans went on a real estate orgy. [Americans] traded up, tore down and added on.”

Governments continue to promote housing and home ownership using rising wealth from home ownership to mask lack of growth or declines in real income levels and uncertain employment for the population. But the policy is paradoxical.

Current policy, lower interest rates and increased availability of housing finance, boosts the price of existing housing stock rather than increasing housing construction. If it succeeds, then higher house prices ironically make housing unaffordable for large portions of the population.

Where the policy fails, an unwinding housing bubble is difficult to manage, as evidenced by events in the US, Ireland and Spain.

Economic activity slows as individuals and investors suffer large falls in wealth. Governments suffer revenue losses from lower property taxes. At the same time, government expenditures may rise as savers are forced to turn to available social services due to falling income and wealth.

Banks can find their solvency affected quickly by a fall in houses prices because of their high exposure to mortgage loans or property as security, requiring government support.

A considered debate about housing is needed to improve the structure of economies. It may also have an unexpected collateral benefit, improving TV entertainment beyond shows about the property or housing ladders and lift the standard of dinner table conversation above the level of: “Do you know how much they got for the house down the street?”