Wednesday 5 January 2011

Dealing with the Deficit (5) - Is the Coalition's Plan "Progressive"? Is it Fair?

On being Progressive, distributional impact, fairness, cabbages and Kings (and why the sea is boiling hot and whether pigs have wings - well, not really.)

This article follows on from previous articles outlining the economic arguments around the Coalition's budget plans, introducing the structure of the public finances and the plans for reducing the deficit, looking at the feasibility of closing the deficit by cutting military spending and an analysis of the taxation changes. This is the final article on the distributional impact and fairness of the government's plans.  I've separated them out to try to keep them shorter.

"Progressive", "Fair".

These are undoubtedly the words that have come to define politics in Britain over the last couple of years. Not necessarily in terms of actual policy enacted, but definitely in terms of the language of our political discussion.  We argue about whether policies are wise, whether they are affordable, whether they are right, but more and more we have come to argue about whether policies are fair or progressive. It has been one of the changes wrought by the 13 long years of Labour rule. Today these terms are thrown around like cheap confetti by almost every party and politician of whatever hue or stripe as basically synonymous terms.  This widespread usage by completely opposing politicians to describe contradictory policies may give you the impression that these terms are largely meaningless. And you would be right. But the question is, can we save any precise meaning at all from this avalanche of linguistic abuse?

'Fair' is one of the first words that any child learns, as any parent or child can tell you.  A sense of things be fair or unfair is one of the most basic of human judgements, and arguably the basis of much of our moral sense.  Like all such terms though it has no clear, definable meaning.  We all think we know fair and unfair when we see it.  Roughly, it means equitable, in proportion with what is right.  It is, in other words, a value judgment. In other words, referring to various policies as fair, is little more than declaring you think they are morally right and/or a good idea, i.e. it conveys almost no actual information, since we generally assume that if someone is pushing a policy they think it is good/right.  It would be bloody odd if politicians were pushing policies they personally thought were a load of immoral rubbish. Referring to a policy as 'fair' is generally useless. But what it can do, at best, is to imply a certain, not only efficient but also, moral judgement about the effects of a policy. But beyond that it's pretty empty.

'Progressive' is a slightly different (but equally annoying) kettle of fish. It has become, if anything, even more prominent than 'Fair'as a political descriptive. It sadly lacks 'Fair's basic and understandable connotations.  It is a technical term, just one with a vague definition. For a while after I heard it first it confused me because I had no idea what it meant. From context I could only tell that it seemed to mean 'good' in a vague sense, but I could not at first work out anymore than that. So I spent some time studying it. Taken literally progressive means to to support progress, but that is little more than a tautology. No politician claims to be opposing progress, any more than motherhood or apple pie. So where did this word come from?  The answer is that it came from America, and it became more and more popular first among Labour supporters and politicians in the 1990's to describe themselves, and then among others. As far as I could tell from some study these people seemed to use it to mean Socialism without the state ownership of industries (since that has been discredited since the 1970's). More generally it has come to mean fluffy and friendly and kind and good, and most importantly: us, as opposed to them.  On which basis it was also appropriated by first the Liberal Democrats and then more recently even the Conservatives, and particularly the current Coalition government.

In defence of some of those who use it though. There is one area where the term progressive can be said to have a precise meaning. That is, in reference to fiscal policy.  In particular, taxation.  A tax is progressive if it hits the rich harder than the poor.  This originally could mean just in terms of the amount raised.  these days however it generally means as a proportion of income.  That is, for a tax to be progressive it must take up a higher percentage of the income of the rich than the poor, rather than just a larger cash amount.  The opposite of this is regressive.  To give some examples: Income tax is progressive, because it is charged at higher rates the higher your income is;  VAT is more or less neutral, because rich and poor pay at the same percentage rate; The BBC licence fee is regressive, because it a flat amount charged regardless of income, and thus obviously takes a higher proportion of the income of the poor than the rich.

In extension to this financial system or policy of spending and taxation is progressive if it enhances the opportunity or chances of the least advantaged in society, generally in terms of redistributing money from the rich to the poor in society, or at least hitting the rich harder than the poor in percentage terms.  And is in this sense that we can analyse whether the Coalition's deficit reduction plan is progressive, as the Chancellor claimed, first at the June budget, and then at the CSR. This was an important point, after the Conservatives campaigned claiming Progressive credentials, and also to the Lib Dems

This is a big question.  Is it possible to have  major deficit reduction plan of tax rises and spending cuts that is also progressive, in the sense of hitting the rich proportionately financially harder than the poor?  Or, in other words, how does the government's deficit reduction plan impact people differently across the income distribution.

On the one hand the government has raised taxes on the rich and taken efforts to protect core areas of progressive spending on health, education, welfare and international aid, as well as for children and pensioners.  On these grounds it claims its plan is progressive.  But this has been strongly contested, to say the least, by other groups.  The analysis of the government's plans has been divided into two separate sections.  We have had distributional analyses of the impact of the changes in terms of taxes and benefits, and then separately the estimated impact of the spending cuts.  These can then be combined to give the over-all impact of government's deficit reduction program by income decile of the population (the poorest to richest tenths of the population).

My personal view has always been that the government has tried quite hard to make sure that we are "all in this together" in the sense of the pain of deficit reduction being shared across the population.  But that it would be almost impossible for any significant deficit reduction plan to actually impact the rich harder than the poor, without being mostly consisted of crippling tax rises.  If I had to guess I would say that the government's plan will likely hit the poor two to three times harder than the rich.  Because our system is so progressive anyway, meaning that the least well off benefit more from welfare and rely more on public services, and pay less in tax, pretty much any attempt to reign back what the state does will hit the poor harder in proportion to the rich.  That is, although the rich will contribute more to the deficit reduction plan in terms of cash this will still consist of a smaller portion of their income, due to the disparity in income, and the extent to which government spending is slanted to benefit the less well off, and that raising taxes on the rich is actually quite hard because they pay high taxes already.

Analysis of the distributional impact of the government's spending plans breaks down into two sections: Welfare and Tax changes, i.e. direct cash transfers, and departmental spending cuts i.e. estimated value lost from services received.  The first of these is relatively easy to estimate, as it involves actual cash transfers, whether in terms of welfare or taxes.  The second is somewhat more dubious, as is involves estimating the value people receive from public services in terms of a cash value, and then guessing how spending cuts may have affected this cash value.

The first off the blocks to attack the government's claims of the progressive nature of its deficit plan was the IFS.  The Institute of Fiscal Studies has actually been around for 35 years, but has recently seemed to appear into the media consciousness.  It is a think-tank that produces work looking at the details and effects of the financial and distributive effects of policy.  Since the Coalition took government its pronouncements on the impact of government policy have, for some reason, been received by the media with a degree of trust and authority generally reserved for Holy Writ. This slight oddity to one side though, it is true that the IFS' research is generally very good. And an excellent starting point.

The IFS produced a report on the distributional impact of the Tax and Welfare policy changes by income decile, but not the impact of the public spending changes.  The most relevant graphs is below.  It shows the impact of all the the tax and welfare changes proposed by the government up until the CSR in October, apart from the CGT rise and the Child benefit changes.

That means by income decile from poorest to richest the changes will mean a hit on income of:

DecileImpact (£/year)Impact as % of net income
2 -£750.00-5.0%
3 -£800.00-4.5%
4 -£850.00-4.3%
5 -£800.00-3.5%
6 -£900.00-3.6%
7 -£1,000.00-3.2%
8 -£1,000.00-2.8%
9 -£1,200.00-2.6%

From the graph it is clearly visible that by income decile the changes are somewhat regressive across the income distribution from the 1st-9th deciles, though the richest 10th do take a particularly large hit.  It is solidly progressive in reference to the amounts involved, but not progressive enough to make it progressive in terms of the percentage hit to income.

The picture does change slightly when looking in reference to expenditure by decile, particularly for the 1st decile but not substantially.  It should also be noted that the proposed changes to child benefit and the tax hike on CGT were not included, due to the difficulties of modelling this.  These changes would obviously hit the rich, making the over-all package more progressive.  But probably not enough to completely change the over-all picture.

Now this is all pretty uncontroversial as an analysis.  The government's defence of them though is based around a couple of points.  Apart from the elements not included, GCT and Child Benefit, they argue that just looking at the static figures of forecast changes in net income at one snapshot in time is to miss the point.  The government is reforming the welfare system and the public services to prioritise spending and structures in such a manner as to help people get themselves out of poverty and to improve their situation over time, rather than just giving them welfare to alleviate their poverty.  A major part of this is the planned 'Universal Credit' that the government will bring in, which is not included in any of these figures.  The government claims this will combat the poverty trap and make it easier for people to get themselves out of poverty by 'making work always pay', and involve a £2 billion initial increase in spending.  Other investments include the Pupil premium and plans to invest funds in early years education and support rather than higher benefits.  

How outrageous you find these figures will depend on various things.  They are at least relatively unequivocal.  That much cannot be said for the second part of a distributional analysis.  This is the attempt to look at the relative impact of spending cuts and, ideally, to give this a monetary value so the "progressivity" can be measured and compared.  For this we must turn to a set of studies fronted by the Trade Union Congress and the Fabian Society.  Following the final plan outlined at the CSR in November they released their final analysis of the distributional impact of the spending cuts.  As may be expected from the TUC, it came out with some pretty lurid headlines:

"Spending review will hit the poorest 15 times harder than the rich"

that were repeated by some of the more gullible parts of the media.  Fortunately though, once one dives behind the figures it quickly becomes apparent that they are nonsense.  I will now explain why.

The initial figures they give are these:

DecileImpact (£/year)Impact as % of net income
1 (poorest)-£1,913 -29.5%
2 -£2,164 -18.5%
3 -£2,124 -15.0%
4-£2,019 -11.7%
5-£1,914 -9.6%
6-£1,865 -7.6%
7-£1,727 -6.2%
8-£1,627 -4.9%
9-£1,560 -3.8%
10 (richest)-£1,506 -2.0%

They get these figures by taking the amount given for spending cuts by assuming we receive the implicit monetary value for public services equivalent to the money spent on them, divided by the number of people in the population, and this is our total income, in addition to the money we directly receive as income in welfare, wages, rent, pension etc.  They then simply work out the amount the spending cuts represent of this and deduct it.  That gives the impact/year figure.  The figures vary because it is slightly more complicated than total public spending divided by population, as you can work out that the benefit of some spending disproportionately accrues to certain income deciles.  For example, the richer you are the less likely you are to use state schools, or some spending, such as social housing, obviously mainly benefits the poor, etc.

Luckily though, this approach is bollocks.  For two central reasons.

The first of these reasons is the assumption that we directly experience a cut in public spending as an equivalent decrease in the value of public services received.  Or, in other words, that it is impossible to make public services more efficient, that quality of service is directly linear to money spent, that all public spending is at perfect, maximal efficiency.  This proposition, once actually stated, is so ludicrous that once clearly stated it requires little more argument against it.

This is not at all to say that public spending cuts will not effect the value of services that the state is capable of providing, they will.  But certainly the effect of any cut in spending is not directly linear.  If Doctors take a 10% pay rise, this does not necessarily mean they heal 10% more people than before.  If they take a 5% pay cut, it does not mean they achieve 5% less.  Just as if a company manages to cut costs, as they often do, this does not mean the value of the products or services they offer declines by the same amount.  After a decade of splurging growth in public spending under Labour it would be odd if there were not some room for greater efficiency in the £700 billion of public spending. Or if, now faced with the unavoidable reality of shrinking budgets, the combined ingenuity of public sector workers were not now able to find some way of saving money now it is truly necessary, more than before when it was not.  Equally ridiculous is the assumption we all gain linearly from the increases in government spending.  I support the Coalition's commitment to raise International Aid to 0.7% of GDP, a commitment worth £2.7 billion.  But I still don't think we each are £50 a year better off because of this change, as stated in the TUC's ridiculous calculations.

The second of these reasons is that even if accept the actual figures for the impact of the spending cuts on our 'real' total income, the percentage figures they most prominently give, and on which their headline claim is based, are the wrong figures.  By that I do not mean that someone's calculator is broken, or that someone has failed to carry a three somewhere.  These are the correct answer to various sums, it's just those are the wrong sums.  These are the wrong whole set of numbers.  They have been substituted for the set that should have been used because they give better headlines.  They are a statistical sleight of hand.  The reason for this is that these figures have been derived by calculating a theoretical 'real' total income based on actual explicit income and the implicit cash value of our access and average use of public services. The cash figures for the impact are the impact on this real total income, since obviously spending cuts, unlike tax changes, do not effect actual explicit income at all. However, the percentage figures for the impact have not been calculated in reference to this total income including the value of public services, but to just ordinary explicit income (the actual wages, salary, pension investment income etc people receive).  This is wrong.

It is not only wrong it is also ridiculous. Taken at face value it claims that a 11.5% cut in public spending produces a 30% fall in income for the poorest 10% of people.  From which it is trivial to calculate that a 50% cut in public spending would cause a 128% fall in this group's income.  That is, according to this model, they would not only have no income  at all, they would owe money each year, even after they had paid taxes and before they had spent any money. Even though they would actually still both have their explicit income and half the implicit income they had before. This is obviously nonsense.

The correct calculations would have been to calculate the loss as a percentage of total real income, as this is what it is a loss from, which then brings us back to the realm of sanity and percentage decreases below 100. And the report does actually helpfully contain these figures.  So why have they not been used in the headlines figures?

The answer is simple: political point scoring.

Because the figures for total income are much larger, and much more equal (because benefit from public services is much more equally distributed than income), the percentage fall for each group when expressed properly is much lower, and is lower for the poorest groups most of all, because their implicit income represents such a larger proportion of their total real income.  This means that when calculated properly the ratio between the impact on the richest and poorest, i.e. how many times harder the poorest are hit than the richest, is a much smaller number.  The real numbers are these:

DecileImpact (£/year)Impact as % of Total Income
1 (poorest)-£1,913 -8.7%
2 -£2,164 -7.2%
3 -£2,124 -6.5%
4 -£2,019 -5.7%
5 -£1,914 -5.0%
6 -£1,865 -4.5%
7 -£1,727 -3.9%
8 -£1,627 -3.5%
9 -£1,560 -2.9%
10 (richest)-£1,506 -1.7%
Ratio of Impact from Poorest to Richest: 5

And those numbers do not look nearly as impressive as the previous numbers, though they are still clearly regressive across the income distribution.

In fairness to the TUC and their leftist stooges at the Fabians, it is very difficult to calculate a clear total for the impact of the spending cuts.  There is a clear urge to have some actual numbers to use, rather than vague intuitions and emotional appeals, but there are real difficulties in working out the numbers properly.  If one scrolls to the bottom of the IFS presentation on the impact of the tax/benefit changes I provided, one gets their own take on the difficulties of doing this.  They use more words, but essentially they go well you can try this model, or you can try this model, but they're all a bit rubbish so we're actually just not going to bother even trying.  The TUC may have been wiser to heed this (implicit) advice.  They would also have been more moral not to try to massage the figures for their own political purposes.  Bad Trade Union Congress.

With these figures it is also now possible to combine them with the tax/benefit figures to get total estimated figures for the impact of the Coalition's deficit reduction plan in cash and percentage terms.  These final numbers are:

DecileTotal Reduction in Cash terms% of Total Income
1 (poorest)-£2,513 -11.1%
2 -£2,914 -9.5%
3 -£2,924 -8.7%
4 -£2,869 -8.0%
5 -£2,714 -7.0%
6 -£2,765 -6.6%
7 -£2,727 -6.1%
8 -£2,627 -5.5%
9 -£2,760 -5.0%
10 (richest)-£5,256 -5.7%
Ratio of Impact: 2

As you can see these figures are again clearly regressive in percentage terms, but the ratio between the impact on top and bottom has come right down to about 2:1.  This is probably about as accurate as we are likely to get.  It is probably then somewhat of an underestimate in terms of the actual impact on people, because the poor have so much less anyway, any hit is going to hit then relatively harder, as they have so little to spare.  So perhaps throw in another unit to our ratio of impact:  3:1.

(At this stage I would like to congratulate myself that these figures of 2-3:1 are pretty much exactly what I predicted at the start.  And I promise I did not work these numbers out beforehand.)

So, the government's deficit reduction plan is certainly not progressive in strict fiscal terms, even taking into account the clouds of dubiosity around the calculations for the impact of the spending cuts.  Can it, however, be defended as fair, or indeed right?

As much as this is probably not a strong surprise by this point, I would strongly say yes.

Considering the scale of the UK budget deficit, some 22% of all public spending, it was pretty much always going to be impossible to produce a serious deficit reduction plan that would be simultaneously progressive.  The only fiscally progressive things in the short term to do in this stage would be to either not tackle the deficit at all or to rely on a massive package of tax rises.  Neither of these options is actually a good idea in the medium to long term.  Massive tax rises would seriously damage the UK economy's ability recover from the recession and grow solidly into the future and act as a significant drag on economic activity on an ongoing basis.  Failing to tackle the deficit just mounts up huge quantities of debt, pushing the cost of spending into the future and compounding it and acting as an equal drag on the economy and government in the future.  Pain delayed in either manner is pain increased, but just stretched out.

Our ability to pay for public spending has dramatically decreased, it only makes sense in that circumstance for our public spending to considerably decrease as well.  Such a path now allows us the chance to get the UK economy and public finances back onto a sustainable path and to ensure prosperity into the future, including the ability to raise spending and welfare again.

The other point worth making is to stress that these reductions are not the end of the world either.  Over-all public spending is being reduced in real terms to the level it was in 2005, as a percentage of GDP to the level it was at in 2003.  In neither of these years did Britain resemble some Victorian wilderness with the poor in workhouses and children down mines or up chimneys.  Neither is there any reason to believe Britain will descend into any of the more lurid fantasies of various figures on the left over the next few years.  Furthermore, although these changes represent on close inspection somewhat fiscally regressive shift in policy it must be remembered that on the wider view this is only a minor adjustment on the massive face and slant of public service provision and taxation.  British public spending and taxation is currently progressive to the tune of hundreds of billions of pounds a year, and after all these changes are completed in four or five years it will still be progressive to the tune of hundreds of billions of pounds a year.

Realistically the Coalition has gone to considerable lengths to ensure core progressive spending survives the cuts relatively unharmed.  Schools, NHS, Welfare and International Development, arguably the most important progressive areas of spending have all been protected to some extent.  ID has gone up massively, the NHS and Schools have flat-lined and welfare has received cuts of only 8%. Taken together as a block these combined areas of spending will go from about £390 billion to about £375 billion over 4 years. Changes in emphasis like the Pupil premium and the Universal credit are also being brought in to better focus sparse resources in a manner than will help those that most need it.

In a highly progressive system, as we have, significant fiscal retrenchment is always going to hit the poor, as they are the ones that overwhelmingly benefit from the system.  But if that retrenchment secures the public finances, keeps down debt and avoids damaging the recovery in a manner that lays a strong basis for prosperity in the future it may still be in their best interest in the medium to long term.  And this is progressive in the most important and literal meaning of the term.  There are of course certain minimum standards of care to be upheld, and I am certainly not saying that the Coalition's plans are perfect.  But I believe they represent a serious, balanced and bold course of action, facing up to hard and complicated choices, to restore our public finances and economy as quickly as possible while safeguarding our progressive welfare state as far as possible.

It is a common complaint of governments and politicians that they are too timid, too insistent on doing what is popular and too scared to take risks.  That cannot be said for this government.  They are being bold on all fronts, possibly to the point of downright recklessness, leading a dramatic program of deficit reduction while simultaneously majorly reforming almost every branch of the state and constitution.  If they manage to pull off 2/3rds of it they will go down in history as one of the most innovative and successful governments we have had; if they achieve it all it will be a downright miracle.

Either way these issues, and most of all the Government's £110 billion deficit reduction plan will dominate political life and discussion in the UK over the next few years and profoundly affect the lives of everyone in the country.  For the reasons I have given through this series I broadly support this government and the actions they are taking. I hope I have also managed to explain both some of the details, and some of the arguments behind those details, of this most vast, extraordinary, detailed and important of political plans.


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