Fiscal transfers within a country

The ONS has calculated an estimate of the fiscal transfers within the UK for the first time. It shows that London and the South East generate more tax revenue than they receive in government spending, whilst other regions are significant net beneficiaries.

What I find important is not the numbers themselves which are entirely unsurprising, it is the fact they were calculated and published at all. Fiscal transfers within a nation state are a key feature of a stable society. If people begin to associate themselves with a region, rather than the overall country, then the cohesion of the country is called into question.

The move towards devolution of power within the UK has been growing, with mayors, local powers and of course the devolved administrations such as the Scottish parliament. The evidence so far is that granting more powers to the regions of the UK will not satisfy the desire for autonomy, In fact, it reinforces the sense of a separate identity. Publication of figures like those above works to further emphasise our differences.

Comparison to the US and the EU

To get a sense for how important fiscal transfers are to the cohesion of a state, this comparison between the US and the EU is striking. Each blue dot is a EU country, each red dot is a US state. I have used the same scale in both charts to make the differences in the dispersion clear.

Y axis Relative income per head of the population (100 is the average for each group)
Shows much greater inequality between EU countries than between US states.

X axis Net fiscal transfer between states (% of GDP)
Shows fiscal transfers between EU states are tiny compared with those between US states.

The US data is characteristic of a country i.e. large fiscal transfers are necessary within a single currency zone, given any lack of flexibility in monetary policy to deal with cyclical or structural differences. The low level of EU transfers helps show why the Eurozone is having such difficulties. One way forward for the Eurozone is to become more integrated, developing into a proper federal state, including large permanent fiscal transfers.

Perhaps the most remarkable difference between the EU and the US, is the level of attention these figures receive. In the US, this issue gets virtually no attention. If I ask Americans, they have generally no idea what the numbers might be and have never given it any thought. They pay federal taxes but do worry about the geographical split of Federal spending. On the other hand, in the EU it is a massive political issue, despite the numbers being an order of magnitude smaller. The EU budget is only 2% of GDP but generates vastly more hostility than national budgets of 20 times the size. This is a major political hurdle for the Eurozone to deal with, perhaps having the most hostile country leave the EU will help them.

My concern is that the UK is moving away from a “US level” of large fiscal transfers without political awareness or opposition. If the United Kingdom cannot regain its sense of being “United”, then the road leads to full separation.

UK Election – Brexit Views

UK Election – Brexit views

I have found the shift in public sentiment on Brexit to be very striking. A recent YouGov poll shows how people who want the UK to remain in the EU are a minority, even amongst those who voted to Remain.

When I listen to interviews with the voting public, I am left confused.
Many appear to talk as though fears of the impact of Brexit have been disproved (i.e. Brexit has happened already), but then others talk about making a good deal (i.e. Brexit has not happened yet). It is not clear to me if this represents a form of widespread cognitive dissonance, or if the media is splicing together pieces of interviews from different people. It is also possible that it is the media that is confused.

This table gives my brief description of the camps.



What are Re-Leavers thinking?

I can follow the argument that Re-Leavers do not want to reopen the debate, and prefer we leave than to try to change the decision. But I am left confused as to what they think is going on.

One hypothesis I have is that Re-Leavers are under the misapprehension that Brexit has already happened. My metaphor for Brexit is jumping off the ledge of a building.

Stage 1 Decide to jump

Stage 2 Jump and experience sensation of falling

Stage 3 Hit the ground

In this metaphor, we are currently at Stage 1 in Brexit.

Stage 1 It is not too late to step back from the ledge.

Stage 2 This may feel exhilarating, a sense of freedom and elation.

Stage 3 Depends on your view of the economics.

From the Leave campaign, it suggests we were on the ground floor of a prison and can now run and be free in the glorious countryside around us. My view is that we are on an upper floor and it is not yet clear how much damage we will sustain. At least some pain, likely a few broken bones, but hopefully not a critical injury.

I will do an economic analysis of Brexit and its implications for asset markets in another post.

How will Hard Remainers vote in the Election?

I found this FT graphic of the same YouGov poll enlightening. It shows why the Remain group are not having any impact and why Labour are struggling to put together any kind of coherent message.

  • Hard Remainers are not uniting behind any party.
    The Lib Dems are trying to court them but only a small fraction of Remainers are going to vote Lib Dem. In fact, the majority of Lib Dem voters are now in favour of Leaving.
  • Labour support is split evenly between the 3 tribes.
    This is why they have not formed any coherent message on Brexit at all. They are trying to appeal to all 3 Tribes, which of course turns into unintelligible policy pronouncements.
  • Conservative voters are overwhelmingly in favour of Leaving.
    This makes the policy message for Theresa May extremely easy.

UK Election – Costing Manifestos

I have a lot of sympathy with supporters’ frustrations with the simplification in the media of the Labour manifesto to a reductionist analysis of “costing”. Especially when the Conservatives do not even make an attempt to assess the costs of their own manifesto.

Simon Wren-Lewis does his best to articulate how this misses the key parts of the debate. I also found this post by the IFS very clear.

The Labour manifesto is a properly radical document and imagines a set of dramatic changes to the UK economy and the role of the government. No simplistic “costing” will come close to capturing what it is proposing.

However, I do not agree with some of the defences of the economic plan and so think it is worth writing down what I understood the manifesto to mean, and why some of the language used is not helpful.

Spending vs Investment

I find that both sides are guilty of being misleading here. The right calls all expenditure spending when it suits them and the left calls all spending investment. From what I can see Corbyn is in favour of expenditure of all kinds. Here are some guestimate numbers from the manifesto pledges (I am not claiming forensic accounting as I see that as pointless).

  1. Investment in infrastructure – £25bn
  2. Extra spending (NHS, tuition fees etc.) – £25bn
  3. Tax Rises – mainly on corporate earnings and high earners – £25bn
  4. Nationalisation – if done well can argue this is a balance sheet expansion but the amount paid equals the value and so no impact on the government’s fiscal health. It is neither investment nor spending.

If you want to examine the increase in “spending” – this figure of £25bn seems sensible.
Lumping in investment and nationalisation makes it scarier but is misleading.

Should we nationalise?

I agree with S W-L that the debate focuses on the wrong topic. The issue is not whether we can afford it. We should “ask Labour politicians why they think the industry would be more efficiently run under public ownership”. For natural monopolies, there is a legitimate debate to be had.

Should we increase investment

In general, there is a good case for higher investment, made by many economists. But I wish they would also acknowledge the actual problem is not with the economics. The obstacle is political from both the left and the right. Whenever the government is increasing investment, there is often an outcry saying we should prioritise “investment” in the NHS and education. But “investment” in the NHS and education is really spending. The right will perceive arguments for “investment” as a Trojan horse for increasing government spending and the left probably sees it the same way, they are just on the side of the Trojans. The ease with which the left talk about pay rises for NHS staff as “investment” always reinforces my perception that they are happily loose with the distinction.

Budget Deficit – does it get bigger?

What happens to this depends on

  1. How much tax is raised
  2. The dynamic effects of the economic changes

To think about this a bit more

  1. How much tax is raised from increases in higher rate tax rates and corporate tax rates is extremely hard to estimate. It is reasonable to assume that higher tax rates raise a lot less than hoped and so there would likely be a significant increase in the deficit. It is an important issue but also the only one generally mentioned and so I would prefer to park that issue for now.
  2. The dynamic effects of all the proposed changes are very complex – for example
  • Higher spending increases demand
  • Higher taxes reduce demand

If we assume for now that taxes raised roughly offset spending increases, then the net impact on demand and growth is, perhaps surprisingly, not zero. It represents a net increase in demand because the marginal propensity to consume of the rich people being taxed more is lower than the people the extra spending has gone to. This is called the balanced budget multiplier.

Simon Wren-Lewis says that this is clearly a good thing because “when interest rates are at their lowest bound – a tax funded spending increase would provide a much-needed boost to activity, which itself would raise taxes.” He castigates the IFS saying it is time for them “to learn a bit of macro”. He states his view as though it is self-evidently true but I do not follow his argument.

I think the above statement is true only if you assume that rates are at the zero bound and you would prefer them to be lower. He defines austerity as having fiscal policy too tight compared with where you would want to have it from a demand management perspective. While he may personally have that view, it is far from objectively true at the moment. For example, on 10th May the Bank of England Monetary Policy Committee met: 7 members voted to keep monetary policy and rates as they are, 1 member (Kristen Forbes) voted to increase rates by 25bp!

If the Bank of England do not wish to increase stimulus it is not clear why we should assume as obvious that increasing demand would lead to higher growth and higher tax yield. If the Bank of England are correct it would not lead to higher growth, more likely just higher inflation.

What really matters in the Labour manifesto

What is clear from the manifesto is that the current Labour Party have a radical agenda for the reshaping of the UK. Starting with an increase of government spending of around 5% and a similar sized increase in investment. This would be, at least partially, paid for by raising taxes. This is a vision of a country with a larger and more central role for the government and a view to intervene via the tax system to work against inequality by taxing the rich.

This is a set of policies around a vision to get everyone’s partisan spirits engaged. The left and the right will love/hate it on ideological grounds. Perhaps this is why most policy analysis is so misleading.

What is the cost of the Conservative manifesto?

This issue barely gets discussed, but from my quick analysis the Conservative manifesto has plans which damage the fiscal position significantly more than the Labour one. The big issue is Theresa May’s continuing pledge to reduce immigration to below 100k. Back in 2012 the OBR produced projections for national debt with different levels of net migration. The impact is stunning and hugely more important than relatively small changes to current NHS funding.


Understanding the impact of government policy on the deficit and debt profile is important. But the way it is done can be misleading and distract from more important economic ideas. Even more crucial is that we properly explore the economic consequences of all policies, not just the ones that directly affect spending and tax.