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“why do we think that “changing the incentives will in no way change behaviour”?”

The September 2022 fiscal statement from Chancellor Kwasi Kwarteng, is proving controversial for among other reasons, the ‘cost’ of the tax cuts it contains.  For a tax cut to be a ‘cost’ you need to make a couple of assumptions, that (1) allowing people to keep their own money is a ‘cost’, and (2) that changing the incentives will in no way change people’s behaviour.

To tackle the first point that “allowing people to keep their own money is a ‘cost’”.  If last month you worked some overtime and say earned an extra £300, but this month you didn’t have the same opportunity to work the overtime, would you say your costs had gone up by £300?  Of course not, no one would say that.  Most January’s many businesses will put on sales often cutting prices by a third or more.  Do we refer to these price cuts as an increase in costs?  Do the price cuts get added as Expenditure to the company’s accounts?  For both personal and business expenditure we see reduced revenue as just that, reduced revenue, not a new or increased cost.  Many people don’t particularly want to work overtime, valuing free time more than the money they earn from extra work.  In the case of businesses, we don’t bemoan the cost of reduced prices, we see this as an opportunity for the business to get rid of old stock, gain market share, or simply get more sales.  Reduced prices provide an incentive that changes the behaviour of consumers.  So why do we refer to changes in tax rates as a cost?  And to the second point above, why do we think that “changing the incentives will in no way change behaviour”?

Why do sin taxes exist if not in part to disincentivise people from undertaking the sin? 

I have written before about the Laffer Curve _{(Blacklist Press)}, _{(Croydon Constitutionalists)}, the theory that cutting tax rates can result in increased total tax revenue, but even if you are sceptical of this, we all know taxes change incentives.  Why do sin taxes exist if not in part to disincentivise people from undertaking the sin?  Why are ISAs tax-free if not to encourage savings?  Why does the government offer businesses R&D tax relief if not to encourage more Research and Development?

“It might be fair to say these changes are not incentive enough to make up for the reduced revenue of the tax cuts (I would disagree) but it is not reasonable to argue that there is no change to behaviour”

Clearly cutting taxes will impact the behaviour of people.  Lower National Insurance rates incentivises employment, lower taxes on profits incentivises business investment, and lower taxes on income incentivises both increased work and releasing invested funds for personal use.  It might be fair to say these changes are not incentive enough to make up for the reduced revenue of the tax cuts (I would disagree) but it is not reasonable to argue that there is no change to behaviour as a result of these changes.

The government didn’t just change tax rates in the budget fiscal statement.  We heard about changes both to the Inland Revenue rules known as IR35, and the cap on bankers’ bonuses.  Wikipedia refers to IR35 as “anti-avoidance tax legislation designed to tax ‘disguised’ employment at a rate similar to employment”.  First introduced in April 2000, the rules have changed over the years, with the latest change being to repeal the 2017 and 2021 reforms. 

“The naïve assumption behind IR35 is that by changing the tax rules for contractors, you will simply earn the same gross pay and pay more tax, receiving less net pay.  Of course, this is nonsense”

IR35 was trying to stop people filling basically the same role, from being taxed differently based on how they are employed.  This sounds reasonable, except of course that how you are employed does affect your role, and in some cases means different incentives, in this case partly via taxes, should apply.  I have worked in the same industry as an employee, what is referred to as Inside IR35 (in effect agency staff), and Outside IR35 (via a limited company) often referred to as a contractor.  The naïve assumption behind IR35 is that by changing the tax rules for contractors, you will simply earn the same gross pay and pay more tax, receiving less net pay.  Of course, this is nonsense.  Being a contractor comes with additional risks and costs, you really need an accountant, you invariably need to take out additional insurances, and a private pension.  You tend to change role frequently as companies only want you on the books for peak demand, and your lack of security of tenure both provides an incentive to be productive and means you tend to have a good buffer of savings for those periods when you are not earning. 

You might wonder, why anyone would be a contractor with all these downsides?  Well of course it’s because you are incentivised by earning more.  These earnings are both in gross pay (invoices into your limited company) and net pay (working via a company being more tax efficient).  When the Inland Revenue changed these incentives, did they see lots of people stay as they were and simply pay more tax?  No of course not, change the incentives and people move.  The costs and risks stayed high, but rewards reduced, so guess what, people moved to lower risk roles.  It’s not clear to me that the government has ever made more or less money when I have been employed via any of the different methods available.  But what is clear is that the economy has lost flexibility in its labour force, business savings, purchasing of goods and services, charity donations and productivity, when I and others like me simply don’t have the money or the incentives needed for these.

“Over the same period salaries improved to retain and recruit staff in a competitive IT market.  Total reward didn’t change much but the incentive structure did”

Lastly, bankers’ bonuses are not a subject likely to draw huge amounts of sympathy.  But that doesn’t mean private enterprise shouldn’t be able to pay people via the incentive method they believe is best suited for the role.  I worked in banking during the financial crisis and saw my bonus structure change and total bonus reduce.  I should say I worked for a retail bank in the IT department, so the sums involved were far away from those being earned by city traders, but to me and my colleagues they mattered.  Over the same period salaries improved to retain and recruit staff in a competitive IT market.  Total reward didn’t change much but the incentive structure did.  If you believe that moving from a pay structure that in large part rewarded outcomes, to one that mainly rewarded showing up, didn’t have an impact on productivity, we must discuss terms on that bridge I have for sale.

Removing the bankers bonus cap doesn’t increase costs or total reward, it changes the incentive.  Changes to IR35 and tax rates are not costs to government, they change the economy and provide the opportunity (they haven’t gone far enough), to develop the more dynamic high growth economy that will benefit us all.

By Mike Swadling

“I don’t feel I would have this problem if I worked for the government. I mean for starters they don’t seem to have anything that works”

I have a habit of referring to things that work as Ronseal Quick Drying Woodstain.  Many of you will remember the 1990s advert that proclaimed that Ronseal Quick Drying Woodstain, does exactly what it says on the tin. 

One of the challenges with this and my many other 80s/90s British TV references is that in these increasingly interconnected times the person I’m speaking to either isn’t in the U.K. or doesn’t remember most of the 90s let alone the 80s.

I don’t feel I would have this problem if I worked for the government. I mean for starters they don’t seem to have anything that works and there is certainly nothing that does exactly what it says on the tin.

“Surely, they are driving the water companies to invest more and improve services.  They must surely be imposing fines on water companies for reduced service to customers through hosepipe bans.  No, quite the opposite”

The list is endless, as I write this, we have had a drought declared in some parts of the country.  We have also seen many news stories lamenting the lack of any new reservoirs in a period the population has increased by about 10 million.  Thames Water has a desalination plant they have never used, whilst at the same time they are imposing hosepipe bans. 

With all this going on where are Ofwat the water regulator?  Where is the Environment Agency?  Surely, they are leading the fight to get people water.  Surely, they are driving the water companies to invest more and improve services.  They must surely be imposing fines on water companies for reduced service to customers through hosepipe bans.  No, quite the opposite.  Ofwat commissioned a 2018 paper “to analyse and present the options available for making deep reductions to per-capita consumption over a minimum fifty-year period”.  Water companies are far from blameless for the failure to keep a plentiful supply of water flowing, but when Thames Water did try to build a new reservoir in Oxfordshire, the Environment Agency blocked it on the grounds there was apparently no need for it.  This isn’t all that new, the 2014 flooding of the Somerset Levels, was widely blamed in part on the Environment Agency’s decision to stop dredging the rivers, something they were tasked with undertaking, for the purpose of reducing flooding. 

But it’s not just water management that doesn’t work in the UK.  The Department for Business, Energy and Industrial Strategy exists yet our island made of coal, with gas and oil reserves and an advanced nuclear power industry, is not expected to have enough power generation this winter.  Of course, as is made clear in a March statement to Parliament, the department puts every barrier in the way to fracking.  Not long before he became Deputy Prime Minister, that visionary Nick Clegg expressed his opposition to new nuclear power stations as they would take too long to come online.  Of course, the prediction had they been commissioned then is they would have come online about now, right when we need them!

Net Zero and the green agenda are in large part behind these departments working towards grand environmental plans, rather than for the benefit of taxpayers.  But it’s not just on the environment our government lacks the essence of doing what it says on the tin, take for example public health.  Public Health England before they were dissolved had some 5,000 staff, who whilst very productive at telling us how to live our lives were woefully under prepared for Covid 19.  Public Health didn’t protect the publics health, they did however lead to the shutdown of our economy and massive loss of freedom.

Failure is in all parts of our government.  Paul Lincoln the disastrous Director General of the Border Force from 2017 to 2021, described ‘bloody borders’ as ‘just such a pain in the bloody a***’.  Nationally the Police failed to solve a single theft in 84% of neighbourhoods in the past 3 years.  70% of Metropolitan Police officers didn’t make a single arrest in the past year and the RAF has seemingly stopped recruiting on ability but now recruit based on wokery.  We have a Bank of England that is charged with keeping inflation at around 2%, yet no one is losing their well-paid jobs as inflation soars above 10%.  None of these departments are Ronseal Quick Drying Woodstain, they are not even close.  The departments we pay taxes for, and the regulators we rely on, are consistently working against us.

“we need some desire from government to actually act to improve the lives of the citizens of the UK.  Let’s assume for a moment the next Prime Minister ushers that in, and I’m not saying I expect them to, but it is a prerequisite”

What can be done about this?  Firstly, we need some desire from government to actually act to improve the lives of the citizens of the UK.  Let’s assume for a moment the next Prime Minister ushers that in, and I’m not saying I expect them to, but it is a prerequisite.  We need to start with a requirement government departments and quangos act to improve the standard of living of law-abiding UK citizens.

The improvements they are planning to deliver needs to be codified, and for this all-government departments at all levels need published Key Performance Indicators (KPIs) or targets.  Much maligned as targets are, without them we simply have no measure of success, or even an indication of what a department is trying to achieve.  There will be problems, some departments will focus on targets to the exclusion of other activity.  Some may cook the books on the numbers, and if staff submit fraudulent data, then action should be taken.  Others will set easily achieved goals, fine, better to achieve an easy goal that benefits us, than to actively work against our interests.  We will be able to see what an area of government believes is its purpose, and what success it has in achieving that goal. 

It seems as if nothing in government works.  Let’s get back to first principles across the state, with for instance a Police force who police, a Border force who protect the borders, water regulators who believe in ensuring people have water.  And with a costs of living crisis upon us, and a few troubled years ahead, lets hope someone in government apply the principles of Ronseal Quick Drying Woodstain, to provide the services we pay for.