Original URL: http://www.theregister.co.uk/2011/03/25/budget_comment_and_analysis/

Fuel foolery, merger warnings and Budgetary boons

New Budget makes some sensible changes...and some mad ones too

By Tim Worstall

Posted in Small Biz, 25th March 2011 13:47 GMT

Comment What a difference a new government makes, eh? Only parts of the budget are entirely lunatic rather than all of it.

I dealt with the playing around with fuel duty and further taxation on oil companies years ago when it was being proposed by idiot Lefties rather than idiot Tories. That it's someone from supposedly my side of the fence proposing it today makes it no less idiotic.

Setting high prices for something means that we'd like to encourage companies to find more of it and encourage people to use less of it. Lowering tax on fuel and raising tax on profits from finding fuel does the opposite; we really cannot solve a supply shortage by reducing future supply nor reduce demand by reducing taxation upon demand.

The plan to subsidise deposits for first-time home buyers is even more glaringly insane. We've just seen most of the financial system of the western world collapse from the error of lending the money to buy a house to people who cannot afford to buy a house. As a method of digging our way out of this rubble lending more money to more people who cannot afford houses lacks a certain logic to it.

As to the macroeconomics of the budget, the inflation, growth, budget deficit, additions to the national debt: not much can be said really. This is the part of economics that not just you or I, but no one really knows much about. Ninety-nine times out of a hundred, the best prediction you can make about any of these large-scale indicators is that they'll be within 1 or 2 per cent next year of whatever they are this year. Which particular school of economics you belong to, the models you use and even the political party you support doesn't increase accuracy much above this in any direction or for any variable.

Merger warning...

There are, however, three areas that I think fascinating. The first is this mooted merging of national insurance and the income tax system. Historically NI was supposed to pay for the NHS, unemployment benefits and your old age pension. We can quibble about exactly how those should be organised (maybe a little more private, a little less national, in the NHS, but a healthcare system largely financed by taxation seems a worthy enough goal etc) but the notion that there should be, at the very least, a tax-financed welfare safety net is just fine by all – except perhaps for those who get all sweaty over Atlas Shrugged. This has all rather withered away, the link between NI and these things, the only one left is the old age pension, where you must have paid X years of stamp in order to get one.

Even this is now to go, with the pension being paid to all who are citizens of the appropriate age. There seems to be no reason to have the two taxes upon income separate any more: so, the idea to merge the two.

Well, actually, there is in fact a reason why you wouldn't want to merge the two. An entirely political one. If people are paying two separate taxes, then some/all of them will think that they're not quite the same thing. That income tax isn't really 32, 33 per cent as its starting point. Thus tax levels can be higher than they could be with only that one merged tax. And thus, if you're a low tax, small state kinda guy (as Osborne is said to be and as I certainly am) then you'd like the merger because it brings home to people quite how much they are paying. And if you're a large state, high tax kind of person, you'll be against the merger for exactly the same reason.

This has actually been pushed out to consultation, which is a good thing: for so far the debate has been about merging income tax and employees' NI. However, there is also another tax there, employers' NI. The general assumption that most make is that this really is paid by the employers: The general assumption made by most economists is that it is paid by the employees.*

So our starting rate of income tax is not the 20 per cent most think it is, nor even the 32 per cent of the mooted merged system, but over 40 per cent when the three taxes are added together. And the top tax rate isn't 50 per cent, it's more like 62 per cent (employers' NI is as a percentage of pre-income tax and employees' NI gross wages, meaning that you cannot just add the three rates to get a total).

From a Tory, economic liberal, point of view, merging all three would put something of a stop to the cries that this is a low tax country at least as far as incomes are concerned. Which is why I rather expect to see some pushback on this from the left side of the aisle.

Retiring beyond our means

The second truly big change is the rise in the old age pension qualifying age. There's been a bit of pushing around of qualifying age terms in recent years: male and female ages have been equalised, and the qualifying age has gone up a couple of years. But the changes in longevity have been so huge over the past century that this just isn't sufficient.

It's worth reminding ourselves that the pension was not supposed to be a system of assurance, but of insurance – insurance against that happy circumstance of living too long. To clarify the difference: assurance is a form of saving for something that's either highly likely to happen or will happen. Burial costs, for example, other than for those lost at sea, are going to figure in all of our life and death plans. So a system of saving for something so hugely likely to happen is assurance.

Insurance on the other hand is a form of saving (or if you prefer, sharing of risks) about something that is less than likely to happen. Your house burning down for example. When Bismark first brought in the very idea of general or tax financed old age pensions, the qualifying age was 65. Average lifespan (hugely lowered by child mortality of course) was 45 for a Prussian. Average lifespan for someone who had managed to reach working age was more like that 65 figure. So, being rational (yes, I know the idea of rationality in economics has taken something of a hit just recently) your average working man would be trying to save enough to carry him through from the end of working life to his likely age of death: 65-ish.

What the pension did was insure yon sausage muncher against the risk of living too long and outliving those savings. It's a happy circumstance to live long, less happy to do so in penury.

Lloyd George's implementation of the same plan here started the pension at 70, it wasn't lowered to 65 until later and to 60 for women only after WWII. But now, of course, the average age at death is more like 77, 78 for men, 81, 82 for women, and there doesn't seem to be any great slowdown in the rate of its increase (one of the more fascinating, for a given value of "fascinating", demographic facts is that there is now almost no difference between life expectancy at birth and life expectancy at working age. We've largely conquered those appalling rates of death in infancy).

Almost everyone therefore expects to live to an age to collect a pension: it has become assurance instead of the original insurance. The proposal therefore is to tie (as some other places, Denmark among them, already have done) the pension age to the average age of death. In a perfect world, to the average age of death of the previous cohort... Thus the pension becomes what it was originally, insurance against outliving your rational level of savings.

A useful byproduct of so limiting the concept is that it could become a reasonable and serious payment again. If it is something that's paid to only half of old people and paid to all only for six or seven years rather than 12 or 14, then it could be more generous, while still reducing the total cost.

Yes, this is rather bloodthirsty, but something must indeed be done about the long-term costs of rising lifespans.

Making R&D pay

The third interesting little bit is the change to the research and development tax credit. Add this to the previously announced special low rate of corporation tax on patents owned by British companies and we've a quite marvellous tax system for research-based companies. This will of course be of interest to all you technical types that read here unlike the rest: assuming that none of you are planning to either pay NI or retire.

Here's (suitably adjusted for the new rules) what HMRC says about the scheme:

[T]he tax relief on allowable R&D costs is 200 per cent – that is, for each £100 of qualifying costs, your company or organisation could have the income on which Corporation Tax is paid reduced by an additional £100 on top of the £100 spent. It also includes a payable credit in some circumstances.

That's really rather attractive: if you're paying £100k in R&D a year, and making £100k in profits even after doing so, then you've just wiped out your entire tax bill. Add in the sheltering of profits from patents announced a few months back, and if and when you find yourself with a real hit product you'll only be paying 10 per cent corporation tax on those profits from that patent.

Effectively, if you work at it, the UK has become near tax-free for organisations which develop things and then licence the rights to manufacture them. Given that this is one of the things we seem to be rather good at (ARM Holdings and Dyson being just two examples) and given that these are exactly the sort of organisations which employ you technical types, this is really rather cheering for the readership of El Reg. To extend it a little further, these two changes have just made Hartlepool, of all places, an attractive location for an adventure I'm involved in with my day job. And it really does need to be quite something to make Hartlepool attractive really.

So, some good things in the Budget after all, along with the usual insanities. I'm left wondering whether, sometime, without having to schlep off to a parallel universe, we might ever get a budget that contains only good things?

Ah, sorry, forgot, there's politicians involved isn't there, never going to happen... ®

* There's a technical point there to do with the elasticity of supply and demand for labour with respect to price which we'll not go into and which determines who it is: suffice it to say that most of those who understand what that phrase means accept that from most to all of employers' NI is paid by the workers.