Preventing another crisis via Banking reform - forget Vickers, new Nef publication goes back to basics

The New Economics Foundation has published its eagerly awaited guide to UK monetary and banking reform: ''Where does money come from?' Explaining how money is 'created' and tackling the failings of the modern monetary system at a fundamental level.

Quite simply, the old monetary system is not compatible with the new world. This ongoing crisis may have been triggered by a US housing bubble, spread by an under-regulated and incorrectly incentivised international banking system and dragged on by a lack of cooperation over sovereign debt, but the underlying root cause was a money bubble - a bubble of the economy itself. Something that can quite readily occur under the current system of pro-cyclical money(credit) creation. Time to go back to the fundamentals, good stuff from the nef. Lets hope this analysis gets the attention it deserves:

http://www.neweconomics.org/publications/where-does-money-come-from

UK taxation isn’t fair. It has to change – but how?

UK taxation needs to change. Spending cuts alone cannot close the UK deficit, nor is it fair to assume so. But taxation should not reduce productivity and investment at a time when recovery is so important. This analysis makes the case for simplification of UK tax code and increased taxation of unproductive wealth. This will raise additional money from those who can afford to pay it, so that public-cuts do not have bear the full weight of the recession.

The UK tax system is frustratingly complicated. The main streams of revenue for HMRC are through peoples basic income (income tax, national insurance) corporations profits (corporation tax, dividend tax), investments and family privilege (capital gains tax, inheritance tax) and consumption (VAT and stamp duty). There are also numerous other small taxes, allowances and credits.

Tax isn’t designed to pay for politician’s second homes and bank bail-outs. It is for providing the vital services to a society, building roads, funding councils, universities, healthcare, pensions and providing welfare to those in need of it. The basic principle behind taxation is that it is meant to be fair and efficient.

The reason for so many different taxes is not only because there are many different sources of wealth, but because they tax different parts of society. Income taxes are higher for the rich than the poor, because the rich can better afford them and have clearly done better out of society than the poor. VAT is a flat rate on consumption (purchases) and therefore impacts the poor more than the rich, relative to their total income. National insurance is taxed at a lower percentage for higher incomes, so hits the poor much harder than the rich, because it funds health services that the poor tend to use more.

Tax credits and loopholes generally benefit the rich, who can afford to take advantage of them. Warren Buffet (the famous American billionaire) recently noted that he pays a lower percentage of tax on his income then his secretary because of the intricacies of the tax structure in the USA.

Let’s follow a single pound through the system and see how many times it gets taxed before it ends up as ‘wealth’ in the pockets of both employees and investors:

Employees (assume employees are on a salary of £30k per year)

1) A £1 football is purchased from a large and profitable sports store

2) 20p is paid in VAT, leaving 80p

3) The 80p is put towards business costs, i.e. staff salaries

4) The company pays national insurance of about 10%, leaving 73p

5) The employee pays national insurance of about 9%, leaving 66p

6) The employee also pays net income tax of about 15% leaving 55p

Investors (assume higher-rate taxpayers)

1) After costs are covered, the other 80p’s received go to profits

2) 25% is paid in large-company corporation tax, leaving 60p

3) Profits are sent to the investors as dividends, taxed at 32.5%

4) Finally, 41p makes it to the investor (shareholder)

In essence, the taxman has taken 45% and 59% respectively of the price of the football before it gets to the employees or the investors pockets.

The first thing that needs to change is a reduction in the complexity. However well-meaning, a complicated tax code is essentially a tax-credit for the rich who can afford to take full advantage of loopholes. Why have so many tax-hurdles between spending £1 and earning 55p? Why have both an employer and an employee paying national insurance on the same salary? Why not have zero corporation tax and increase the tax rate on dividends and capital-gains?

The wealthy claim that higher taxes on the rich would be a tax on success and entrepreneurship, which would reduce the incentive to invest, start businesses and work hard, thus reducing the UK’s competitiveness. It would also push high-earners abroad, draining the UK talent and investment pool. They say that the state is too big and expensive, and that cuts need to be made to close the deficit and repay our debt.

The poor claim that austerity cuts always impact the poor hardest, reducing their welfare and public services, and cutting a higher proportion of their jobs. They also say that the rich and powerful caused the financial crisis that has hit the poor hardest, and therefore the rich should be taxed more to balance the books again.

Both arguments are correct. This is why tax is such a thorny political issue. The rich can afford to pay more, because they have benefitted most in the ‘good times’ and therefore should contribute more to the collective effort of closing the deficit. However, if the state is too large compared to the private sector (public spending was 45% of national GDP in 2010), then cuts are required to restore the balance between the wealth-creating private sector and the socially-vital public sector. The answer is therefore a combination of both.

However, there are some aspects that everyone should agree on:

1) Tax complexities are designed to be fair, but tend to benefit the rich. Therefore, loop-holes and complex credits should be removed to simplify UK taxation.

2) It is clearly fair to tax the rich more when austerity cuts are disproportionately affecting the poor, but these shouldn’t damage national wealth-creation. The solution is to tax the aspects of ‘rich culture’ that do not create wealth. I.e. increase inheritance tax to as close to 100% as is viable and impose taxes on un-productive wealth such as mansions and luxury items.

Inheritance tax is a controversial issue, but those who receive an inheritance have rarely worked for it. Moreover, those who receive it have usually already had the benefit of a wealthy upbringing, better healthcare, education and family support throughout their life. If people know that they will receive an inheritance when they are older they are not incentivised to work hard and be successful. Morally speaking, inherited wealth should be taxed at 100% (if not already donated to charity), with the exception of an allowance to pass on the family home and some family assets tax-free, capped at a level per-child that reflects the national average salary.

Unproductive assets such as mansions, private undeveloped land and yachts should be subject to an additional tax or a much higher rate of ‘capital-gains’ tax upon sale. Also, a higher rate of VAT should apply to luxury personal purchases, such as expensive cars, art and jewellery. It is true that this will introduce some more complexity, but no-where near as much as the current needless complexity that ought to be removed.

We can then focus upon stomaching these socially-harmful cuts and unpleasant tax increases, to work towards a more sustainable future and a new vision for our economy.

Break-up of audit firms after the financial crisis - Why the current audit system doesn't work

Every UK company of significant size is required by law to publish accounts and be audited annually, this is to ensure that shareholders and other investors can have faith the the company's reported results are 'true and fair'. It is a vital cornerstone of our current economic system that people can review the performance of their current or potential investments to make informed decisions about where to put their money, and thus ensure the ongoing efficiency and public faith in the economy.

The audit industry was recently called 'the dog that didn't bark during the crisis' by the European markets chief. The failure of major bank's auditors to spot problems before the credit crunch has been the subject of deep criticism. The EU is currently proposing to break up the large audit firms on the basis that they are no longer perceived as independent from the organisations they are auditing, a fundamental requirement to do their job. The break-up will mean that audit firms can no longer deliver other services such as tax and consulting to companies that they audit, unfortunately this is where the firms make most of their profit.

The big four (PwC, Deloitte, KPMG and E&Y) dominate the audit industy (auditing almost 100% of the FTSE 100). The problem is that the business model is inherently flawed, as follows:

1. Companies are required to pay for their own audit
2. Therefore audit firms bid to provide their audit services to companies
3. An audit is something that the management of a company generally does not want to have, as it is a nuisance and delivers no real value
4. Therefore auditors compete on a low-cost basis
5. To acheive any kind of profit from a low-cost audit, auditors have to do the job quickly and cheaply
6. This means that the audit quality suffers
7. Auditors also need to keep the company happy as they are the customer paying their fees, so they don't want to raise the awkward questions
8. Management prepare the accounts that the auditors are supposed to audit, so auditors should remain completely independent of management influence
9. Big companies use their low-margin audit services as a 'foot in the door' to provide other more profitable services, such as tax and consulting
10. Essentially, auditors have to stay friendly with management to retain the audit contract and to sell the more profitable advisory services to the company
11. The more profitable services such as consulting often compromise the audit, because the auditor has a vested interest in the company and is now working with management
12. All of this means that the auditor is terrified of finding something that management do not want to hear, as they may lose the contract, and thus make less profit for the firm

There are a whole host of guidelines and ethical requirements for auditors to avoid conflicts of interest, but the truth is that the current business model cannot work. Auditors are looking for something that they don't want to find, and are therefore unlikely to find it. They are profit earning firms and do not want to jeopardise sales.

As long as the company is paying the auditors fees, is it really realistic to think that the audit can ever be independent and effective?

A commercial system whereby auditors compete for contracts on a low-cost basis is flawed. An audit is not a product, regardless of how well an audit is done, the company is not willing to pay more for it. Therefore, the key to a profitable audit is to do the minimum work to satisfy the regulations (so you dont get sued). It may make the shareholders feel better that the company has a supposedly thorough auditor, but in reality it is management that choose the auditor based on who is the cheapest reputable firm.

Auditors should not be commerical firms, but should operate more closely with the regulators, and should therefore be not-for-profit. That means that each company should be required to pay a minimum fee or a percentage of their profits for a truly independent auditor, nominated by the regulator, to audit their books. The auditor is then motivated to audit the company properly, ask the awkward questions and spend more time investigating any issues that come up, without worrying about eating into their own profit margin.

More mis-information from the Telegraph - London riots

Providing another typical example of deliberate journalistic mis-information, the Telegraph online (a serial offender) has reported that:

'Average London rioter had 15 previous offences, figures show' http://www.telegraph.co.uk/news/uknews/crime/8764809/Average-London-rioter-had-15-previous-offences-figures-show.html

Of course, what they actually mean is that the average london rioter who was referred to the courts by the police had an average of 15 previous offences. Which of course makes sense, because the police are unlikely to refer someone to the courts with few prior offences (although 15 does sound rather large). The statement that the average London rioter had at least 15 previous offences is completely incorrect.

It is very frustrating when papers such as the Telegraph deliberately use mis-information and decieve their readers with selectively chosen statistics to promote their own interests, which in the case of the Telegraph is its politically right-wing stance that rioters are simply criminals and should be locked up in jail (as opposed to the poor and disenchanted in society rioting against the system).

As expected, it is not possible to make comments at the bottom of the article in order to challenge the author. You would hope that a reputable newspaper would be interested in promoting transparency and debate, but this simply does not apply to the Telegraph.