February 07, 2016

How to Make a Sourdough Starter Like the One I Use

Writing about web page https://www.facebook.com/thevirtualbagel/timeline

Abstracting from the the details of the science (and there is plenty of that), in practical terms, you need to build a trap that can be used to catch and activate wild microscopic living organisms (sourdough cultures), which float around in the air we breathe and which lie dormant in the dried flours and waters that we make our bread with. These include yeasts, which make the bread rise, and the “right sort” of bacteria, like the bacteria in yoghurt, which make the bread taste sour. Shop bought dried active yeast, is just that, yeast. To get the sour into the dough, one also needs the bacteria.

The mix of wild cultures that you catch might depend on where you live. As some of these wild sourdough cultures float around in the air, the specific flavour and rise delivered by a wild culture trapped in one location could very well be completely different from the flavour and rise generated by wild culture trapped in a different location. I have heard that the sourest and best risen sourdough is produced from the wild cultures of Bahrain, which is very different in character to that produced by cultures trapped in San Francisco, home of the famous, modestly risen, “San Francisco Sourdough”, a wonderful bread with a chewy texture and mildly sour flavour. I have a theory that when you move sourdough cultures from one location to another, they will slowly but inevitably change character through contamination with new local cultures and airs. But I have yet to test that theory systematically. As a precaution, every time I catch a new culture, I give it a name and note where and when it was trapped. My favourite starter these days is called “Trevor”, but I have others that produce more or less sour and/or more or less fluffy bread.

Next, you need to know about the trapping of the wild sourdough cultures. I grew up in the wilds of the West Coast of Canada and have some knowledge of trapping, an outdoor pursuit that requires stealth, cunning and patience. Luckily, our prey – the yeast and bacteria that we want to catch and activate for our sourdough – have no eyes and ears so in trapping them, stealth is not a factor. Nevertheless, it still requires a degree of cunning and patience, and if not exactly a dangerous outdoor pursuit (unlike as trapping was portrayed in “The Revenant”), it will still be necessary to make a daily dash to the back garden to stir the trap up, but even this is something that is easily recovered from with the help of a nice hot cup of tea and a biscuit.

As to the trap itself. Put one a half cups of water and two cups of flour into a bowl and mix it well.

Next, you want to set the trap. To do this, put the bowl outside. If you have a lot of non-microscopic organisms in your garden that you don’t want to catch, then place some cheesecloth on top of your bowl. That’s about it. The trap has been set.

Stir the trap once or twice a day and then wait for the activation of wild microscopic organisms in the air in your neighbourhood and in your flour. You know you have made a catch when you see the paste begin to bubble and ferment. This could take several days or longer (like a cricket match), the exact timing all depends on what is in the air that you breathe and the flour that you use, but once your wild culture is good and trapped and your paste is bubbling and fermenting, you can proudly call your paste a Sourdough starter.

After mastering the catching and activating of wild cultures and getting your basic sourdough starter, name it, feed it and keep it alive and when you are happy with it, get baking – you can make all sorts of variations of baked breads (e.g., pizza, pita, flatbread, focaccia). The list is almost endless. Even better, a single living batch of wild sourdough starter can be left to the next generation as their inheritance (especially useful if you haven’t got any other sentimental keepsakes lying around, or even if you do, but want to give them to someone else), and, although I haven’t done this yet since most of the people I know don’t bake bread, you could even give it to some of your friends instead of buying them expensive presents on their birthdays or Christmas – it’s a win-win situation!


If you want to learn more about the history and science of sourdough, then you need to do some research. I didn’t have access to a huge amount of information about sourdough when I started making it, but there’s more and more information available and Artisan Bakeries are becoming more and more popular so the word is spreading. On the internet, a good place to start is Wikipedia’s Sourdough Page. Have a quick read of that and then read it again more slowly and pay particular attention to the section on “Local Methods”, which is about two-thirds of the way down the page. That description of how to develop the sourdough starter is closest to the method that I use.

I always like to start any project by understanding what it is that I am trying to achieve. In the case of sourdough, I just want to create a good-tasting, “chewy but still fluffy” loaf of bread leavened with nothing but flour and water. This stems from a broader curiosity about how to make delicious food with the most basic set of ingredients.

January 31, 2016

Putting Tax Revenue at Risk–It’s Still All About the Base

UPDATE: February 11, 2016
Below is my January 31, 2016 blog about the Google Tax row. I thought it would be useful to retweet it in advance of today’s PAC meeting, which I am looking forward to live streaming later today. The deal still seems to rest on shaky legal foundations, carrying the risk of undermining tax revenue generation in the long run. Nothing about HMRC’s statement of a couple of days ago has convinced me to change that opinion – it came across as being as sincere as a toddler proclaiming, through a mouth jammed with sweeties, that they haven’t eaten any sweeties and that they are really, really, telling the truth. Neither has this impression been helped by reports of protestations from Google that sounded as if they had refused to pay tax on sales since it is the law that taxes are based on income and not sales. This is absolutely correct of course. Nevertheless, the suspicion that they might have refused to pay taxes on sales leaves me wondering if they were asked to pay taxes on sales, and if they were, who was it that did the asking, and so on and so forth, and (I’m just saying) how this might be interpreted through the lens of the principle of legal certainty. In any case, whether or not HMRC and Google are tax sweethearts in reality, there is a perception that they are and this is not going to be improved unless there is complete transparency about how the details of how these tax deals are agreed and trust that the law was applied as it should be. I think that a bit of independent oversight is necessary – as suggested by Judith Freedman in her FT article of a few days ago. In the meantime, let PAC at it.

PS: If one has robust legal rules for paying taxes, one should be able to assess tax liabilities unilaterally without any consultation with the taxpayer. If a tax administration agency has to have a meeting with the taxpayer to get him/her to pay and/or explain why they have to, then the legal foundations for the tax liability cannot be thought of as being robust, but rather shaky in substantive terms, even if nobody has broken any rule or any law.

IT’S ALL ABOUT THE BASE: January 31, 2016
HMRC has made a tax deal with Google, a company worth billions of pounds, which allows them to pay £130 million in tax arrears. There is an unhealthy lack of transparency in the details of how HMRC came up with the £130 million figure and this has served to fuel the raging debate currently being played out in the media about whether or not Google, a multibillion pound corporation, has received special treatment from the tax authorities. Some commentators have reported that the deal amounts to Google paying an effective corporate tax rate of 3%, which is much less than the 20% statutory rate (see this report). My conclusions are that the deal seems to rest on shaky legal foundations and carries the risk of risk undermining tax revenue generation in the long run.

The starting place in thinking about all of this is to understand the principle that determines which tax jurisdiction profits are generated in. For a fully domestic firm, sales and production both take place within national boundaries, but this is not true for a multinational firm, which produces its goods and services in one country (or countries) and sells them in a different country (or countries). This raises the issue of what basis should be used to assess profit taxes of multinational corporation: the basis of the tax jurisdiction where sales take place, or the basis of the tax jurisdiction where the income is generated (i.e., where production takes place). The prevailing principle that all countries use is to base profit taxation on the location where income is generated and not on the location where sales takes place. This means that if a business sells 50% of its goods in the UK but produces all of these goods outside of the UK, then that business is not liable to pay any corporate taxes to the UK government. It does not mean that these goods escape taxation since there are taxes that need to be paid on imported goods, but those are sales taxes, not profit taxes.

Implementing profit taxation based on the location of where its income is generated is not always straightforward. Businesses that own foreign subsidiaries can use internal artificial accounting conventions (transfer pricing) to manipulate the amount of profit that they report in each tax jurisdiction, and even though there are rules in tax law that are specifically aimed at containing transfer pricing abuses, it is very difficult to monitor and identify them. Nevertheless, even with the risk of transfer pricing abuse, which is fundamentally an accounting concern, the general principle that profit taxes are based on the location where income is generated rather than where sales are generated remains. There are two main reasons for this.

First, there are efficiency reasons. Profit taxation based on the location of sales creates distortions in firm behaviour. This is economically inefficient in and of itself, but it can also lead tax jurisdictions to engage in welfare worsening tax competition. Consider the following example: Suppose there is a Kazakhstan exporter of widgets that produces widgets in its Kazakhstan factory and sells half of what it produces to the UK. If it does not own any subsidiary in the UK, then according to the general rules, it is not liable to pay any profit tax in the UK. Now suppose that the same firm, without changing anything about its production – widgets are still being produced in its factory in Kazakhstan – is thinking of opening a tiny one room office in the London that is staffed by one person. Maybe it wants to do this because it thinks it would be helpful with local promotion of the widgets and maybe, for legal reasons it would be convenient to have this office take the legal status of a fully owned UK subsidiary. If profit taxes were based on sales, then this small change, which has no marginal implications for how the Kazakhstan widget business is run, would trigger a 50% profit tax liability. Thus, it is pretty clear that the Kazakhstan firm would not entertain the notion of opening a subsidiary in the UK for very long. It would just not do it. In general, a legal tax regime based on sales and not income generation, would be unsustainable since it would generate large distortions in the behaviour of firms who would make decisions about whether or not to open local subsidiaries on the basis of tax convenience and not for business reasons. It would also trigger disputes between tax jurisdictions, and encourage welfare worsening tax competition between them. In the example, if the Kazakhstan widget producer did have a subsidiary in the UK, but then experienced a higher tax rate in the UK in comparison with China, it would simply shut-down its UK subsidiary and re-open it in China. This might induce the UK to offer a tax concession aimed at luring the subsidiary back, and then China would respond and a `race to the bottom’ in tax rates would be triggered.

Second, even if we wanted to depart from profit taxes based on the location of income generation, and instead assess profit tax liabilities on the basis of the location of firm sales, it would be administratively difficult to do so with sales of services. Sales of physical goods, both domestically produced and imported, are assessed for VAT tax purposes, but it is extremely difficult to do the same for imports of services. This means that in the case of services, it is not likely that there would be any reliable way of measuring domestic sales. We are left with the prevailing principle: profit taxation based on the location where the income is generated and not based on the location of where sales are made.

This is not to say that using sales as the base for taxation (not profits determined on the basis of the location of sales, which is a very different thing), might not be a good idea, and indeed sales are already used as a base for taxation — there is VAT on sales of goods and services, which is applied both to all sales of goods, whether they are domestically produced or imported. But there are problems with implementing sales taxes for services, both on the domestic front through evasion (e.g., who asks for a VAT receipt from the window washer that comes by the house occasionally?) and on the international front through problems in assessing taxes due – for imported services, there is not a physical good that crosses the border and whose value can be assessed by customs, as is the case for physical goods. If I order a Google Analytics product from the US and download it on my computer, it is quite difficult to have a system where that sale can become liable for UK VAT taxation. This is not only because it is difficult to keep track of the sale itself, but also because it is difficult to determine where the good is actually going to be used in the end. Maybe I am ordering and downloading the software while I am on holiday in France, or I could download it in the UK, but be doing it behind a VPN server, which is legal and which can mask my location (to get some idea of the complexities involved, see this guidance from HMRC on taxing digital services). This would make it very difficult for Google to collect VAT on the sale, even if they wanted to do so. Indeed at the most recent Public Accounts Committee meeting, which I attended, these issues were the topic of a lively debate that mainly missed these key points.

So admittedly, taxing sales of services is challenging, but this does not mean that one should therefore try to address the “Google problem” by distorting well established and solidly founded economic principles underlying the way that profits are taxed, especially as a knee jerk reactive scramble to find a quick remedy. In this article in the Guardian, Lord Lawson suggests taxing UK sales (the IFS suggests the same in their January 29th Observations article), and this is a reasonable thing to say; however, no reforms of the basic economic principles of taxation is implied in this, nor are they needed, because the principle of taxing the sales of goods and services is already in place. Rather, it is a problem of implementation of sales taxes that is the issue in the case of international sales of services and this needs to be the focus if the debate moves further in the direction of resorting to sales taxation.

It may be very frustrating for the public and government to see an international company such as Google, which has a large business interest in the UK, paying little taxes. But that is not a good reason for trampling over sound economic principles and for not sticking to the rules that are set out by the existing tax code. If the UK government or HMRC (rightly) feel that the current tax regime is less than satisfactory, then they should concentrate their efforts on reforming it, and endeavour to negotiate tax treaties with other tax jurisdictions – rather than negotiating what are being perceived as ad hoc deals with individual corporations. Indeed the OECD has been trying to move in this direction with its Base Erosion and Profit Shifting (BEPS) project and the EU’s recently announced Anti Tax Avoidance Package, which “contains concrete measures to prevent aggressive tax planning, boost tax transparency and create a level playing field for all businesses in the EU.’’ These initiatives provide an excellent basis for engaging in international tax negotiations.

But there is an even more fundamental reason for why these seemingly ad hoc deals are a bad idea, and that is that they seem to be based on shaky legal foundations. I cannot see how it is a good idea to improvise criteria for determining tax liabilities, which are not enshrined in the tax code (or if not improvise, be perceived as improvising), or even worse, to negotiate those criteria with individual businesses (or if not negotiate, be perceived as negotiating). This violates the basic principle of legal certainty, is rightly perceived as being unfair and unjust both by businesses (who feel unjustly targeted) and by the public (who perceive those same businesses as receiving special treatment), and creates a climate of business uncertainty that can discourage business investment in the UK. Abiding by the principle of legal certainty in tax matters is not in conflict with HMRC’s mandate to maximise its tax revenue collection applying a “risk management” approach: if one takes a long-run view of these objectives (as one should), uncertain and renegotiable tax rules carry the risk of risk undermining tax revenue generation in the long run.


About me:

I am an expert on the economics of international taxation. I have published papers on transfer pricing, international tax evasion, and international tax competition. I am also Editor-in-Chief of International Tax and Public Finance, one of the leading academic field journals in public economics, which has a special emphasis on the open economy or, more generally, interjurisdictional issues, the interaction of policies across jurisdictions and the effects of those policies on economic (and political economy) outcomes.

November 28, 2014

Business rates..

Follow-up to Public benefit and independent schools from Kimberley Scharf's Blog

The arguments that I made in my original blog, which are based on economic principles, also apply to the “new” debate about forcing independent schools to pay business rates. Using similar economic arguments, it is easy to see that this is another idea that makes no economic sense.

January 06, 2013

Divorce rates are down a bit. Not to worry, Child Benefit reform is on the way.

The upcoming change in Child Benefit is puzzling to me on several fronts.

First, child benefit is a longstanding measure that individuals will have counted on in formulating their irreversible long-term plans (we cannot choose to “un-have” our children – as much as those of us who have teenage children may sometimes wish we could). Changing it with so little notice cannot be too helpful for restoring households’ economic confidence, which in turn cannot be too good for growth.

In addition, the means-tested phasing-out provisions effectively imply that individuals with incomes between £50,000 and £60,000 will face a higher rate of taxation on every additional pound they earn than do individuals with incomes above £60,000; and they will only do so if they happen to have children. So, a bachelor on £100,000 a year who receives a £10,000 salary raise will be able to keep about £6,000 of it (gross of other contributions), whereas a working mom on £50,000 a year who receives the same £10,000 raise may be able to keep as little as £3,500 of the same salary raise. This is a feature that does not come across as particularly fair or attentive to individuals’ incentives.

Leaving all that aside, the most unusual aspects of the reform are its implementation details – as was made evident by the intricate flowchart that people received in the post back in the autumn. Not only does the change in child benefit introduce a new level of complication that seems to go directly against the stated objectives of simplification and red-tape cutting, but the fact that the benefit will be based upon the individual income of the highest income family member and not on family income, as is the case for other forms of child support, introduces incoherence in the welfare system. And, more worryingly, it means that couples will have to coordinate with one another on the details. One forum user on Mumsnet summarised her opinion as follows: “… it’s apparently fine to have independent taxation when it comes to married couples allowance being abolished, but now my husband and I are considered together for child benefit. So he has to declare a benefit I claim. I am expected to tell him I claim it and he’s supposed to tell me his salary…”. This may be the proverbial last straw on a strained marriage’s back – I could instantly picture a number of colourful scenarios where this might lead to conflict and divorce (and thus children losing more than just a monthly cheque …).

The costs and benefits of the change are as of yet hard to quantify, but the government does not seem to have made a serious attempt at doing so itself and has dismissed authoritative attempts by others (such as the report prepared by the Institute for Fiscal Studies) as if they were politically motivated. We can all accept the principle that the better off should be called upon to do their bit to help improve the public finances, but “making tough choices’’ – a soundbite that the current government seems to be particularly fond of – does not mean that those choices cannot be careful and informed.

Mumsnet forum

IFS report on Child Benefit reform

November 27, 2012

Charity and Christmas: a message about giving

Writing about web page http://www2.warwick.ac.uk/christmas2012#kim

Give to charity this Christmas

Here is the video of my message about economic reasons for why you should give to charity this Christmas (the transcript is below):

I’m here to say a few words about Christmas on behalf of the Economics Department and the University of Warwick. My Christmas message is about “Charitable Giving at Christmas”.

Christmas is a time of giving. We give all sorts of things at Christmas: we give our loved ones presents under the Christmas tree and kisses under the mistletoe; Father Christmas, Hanukkah and Kwanzaa give gifts to children all over the world; we give Christmas greetings to our neighbours and to our friends, and we give smiles to strangers. Christmas is indeed a very special time of year.

But there is another kind of giving that we also do, and not just at Christmas time but throughout the year. This kind of giving is directed not towards our loved ones but towards strangers. We call this charitable giving.

I’m an economist. A lot of people might think of economics as being all about people trying to make lots of money for themselves. But actually, economics is also about charitable giving. Charitable giving is a really important part of economic activity, and it is something that we actively study as academic economists.

Why do we give to charity? Do we do it because we care about others and feel for them? Do we do it because our religious beliefs demand it? Do we do it in memory of those who are no longer with us? Or maybe charitable giving motives are not that charitable? Maybe we are trying to show off to our friends, our colleagues, our business associates?

We still don’t fully understand the real motives behind charitable giving. But more and more people are studying this question and we are getting closer and closer to understanding the answers.

Whatever the reasons for it, charitable giving and the activities that are funded by it – activities that take place in the charitable sector – represent a big and growing fraction of all economy activity: there are almost 163,000 charities registered with the UK Charity Commission, and in 2012 their total annual income was almost 60 billion pounds; of that total, almost nine and a half billion pounds came from charitable contributions made by people from all over the United Kingdom. And market economies have now come to count on private giving to function properly and invest in the future. For example, in the UK, charitable donations towards medical research amount to more than one billion pounds, which represents more than one-third of all public expenditure on medical research in the UK.

What is the link between charitable giving and Christmas time? At Christmas time, we all watch reruns of a “Christmas Carol” and Frank Capra’s “It’s a Wonderful life,” which ends with Jimmy Stewart being saved from financial ruin by his community all coming together to help him. At Christmas time we are all tingling inside with nice feelings towards others. But do these nice feelings and tingling sensations translate into more charitable donations? Yes, they do. Charitable donations do increase around Christmas time and throughout the month of December. This ‘December effect’ may even amount to something like a doubling of charitable donations in comparison with levels of giving in September, or October or November.

But times are hard. The recent economic troubles mean that the needs of those counting on charitable giving have become greater than before; yet government budgets are tighter, and so are the budgets of individuals and households that give to charity. Giving is needed more now than ever, and yet recent figures show that giving is down on previous years – there were almost 2 billion pounds fewer charitable contributions made this year compared to last year, which is a drop of more than 15 percent. It’s beginning to look a lot like a Grinchy Christmas for the neediest.

Then, my Christmas message is this: please, give this Christmas, and not just to your loved ones, but to charity. Why am I, an economist, telling you this? Because academic research says it’s good for you: giving can help you feel more socially confident and this is contagious. Give more to charity this Christmas, and not only will you help others, but you’ll also feel better about yourself and you will encourage others to give and they will feel better about themselves too. Everyone’s happier! That’s beginning to feel a lot more like Christmas to me.


June 26, 2012

What Next George?

See my new blog in today’s Guardian.

Here are the research papers and some slides:

The academic paper is here

Slides with math are here

Slides without math are here

June 12, 2012

Sir William Bull: On Bureaucracy and the Form Filling Ability of the English


While doing some research for a new paper, I came across a revealing Parliamentary debate about the 1909 “super tax” on the rich. Sir William Bull, member of Parliament for Hammersmith, was vexed about the forms and had this to say:

...The form is extremely inquisitorial—more inquisitorial than we have ever had in taxation before, and a great deal of information required by it is already in the hands of the Income Tax authorities, and why people should be compelled to fill up fresh forms when the information is in the hands of the authorities I cannot think, except for the purpose of annoying them. English people have no genius for filling up forms; they always do it very badly, and they always make mistakes. Thousands and thousands of pounds are claimed annually by the Government which ought to be returned to the people with small incomes, if only right were done, but the people are so appalled at the red tape they have to go through in the forms they have to fill up, that they would rather submit to the loss of the money than the time and trouble it takes to get back the amounts claimed; and on this subject I can speak with some authority.

Sounds familiar. I wonder if his perceptions on the form filling ability of the English were widespread and if they formed part of the rationale for PAYE? I will have to look into that.

Full transcript of House of Commons debate held on June 22, 1909 is here

May 31, 2012

Hey George, that U–turn was dope!

Timing is such a funny thing. This morning I presented these slides to a group of Directors of Communication from Russell Group Universities. They summarise my thoughts about the economic insanity of the former proposed cap on tax relief for charitable contributions. I told my audience this morning that I thought the government should do the right thing and completely backtrack on the proposal, after all, when a child has done wrong we expect them to apologise and say sorry. So now the government has done that – not due to my presentation I am sure, that was just weird timing – and I applaud them for it. I also applaud them for listening to the sector’s voice screaming at them that the very limited available evidence would hardly support the notion that the planned cap would be a good thing for public finances or for charity.

So good for you George Osbourne, it takes guts to admit you are wrong and you have my respect, that was dope.

May 09, 2012

Charities should care about the proposed cap

Writing about web page http://www.thirdsector.co.uk/news/1130568/most-charities-dont-care-tax-relief-cap-argues-nick-hurd/

Nick Hurd suggested that most charities don’t care about the tax relief cap. But they should. Because the cap is on combined tax relief – affected are loss reliefs that can be claimed against total income, qualifying loan interest relief and reliefs for charitable giving – it may have unintended consequences for donors, borrowers, and public finances. This is something everyone should care about.

Suppose a combined cap bites for a taxpayer that has some qualifying relief on donations and some qualifying relief on interest payments. Such a taxpayer might not make the same choices about the composition of their relief after the cap is in place as they did before. In fact, all taxpayers who are affected by the cap may have incentives to trade-off reliefs within the cap. Adjustments like these are not part of the proposal’s desired objective, rather they are unintended distortionary effects that might lead, post-cap, to a whole new crop of costly “avoidance” issues. As an aside, calling these “avoidance issues” is so negative, I prefer to think of them as “issues that crop up when taxpayers make rational adjustments to a change in the rules”. Aside over. So we should care about these kinds of things because this “cap on tax relief” public policy might create more problems than it solves. If so, it is not a well-designed policy, creating a lot of hassle for everybody and possibly failing in its objective of increasing revenue.

We can use the HMRC example to illustrate the kinds of distortions that might crop up under the cap. A taxpayer has an income of £250,000 and has invested £50,000 under the Enterprise Investment Scheme (EIS). The taxpayer also has qualifying interest on a loan to the tune of £40,000 and has made a qualifying charitable contribution of £25,000 (in the HMRC example, this is a gift of shares). Total eligible relief before the cap is £115,000, total eligible relief on interest payments and the charitable donation is £65,000. Before carrying on, a very important point to recall is that people are not inert – the taxpayer has made her choices about how much to borrow and about how much to give to charity based on her beliefs about what she can afford, and those beliefs have taken into account her taxes and tax relief and all the other things that might affect her now and in the future.

Once the cap is imposed, HMRC correctly point out that since £65,000 is bigger than £50,000, the taxpayer can only claim a relief of £62,500 (25% of income before any relief). All sorted then, the government gets a bit of extra revenue on £2500. That is the direct benefit to public finances. But what about the costs? They depend upon the reactions of the taxpayer, and we do not have any evidence about those. One thing that is for sure is that there will be some reaction of some sort. The taxpayer in the HMRC example does not react to anything. But the real taxpayer does and she is not stupid so, after the cap is imposed, she actually notices that she has less after-tax income. Accordingly, she has therefore to adjust her beliefs and reconsider all of her choices. And she would have to do this even if the cap were restricted to tax relief on donations. But it is not, it also includes other kinds of tax relief and so the taxpayer has “extra” (and not in a good way) tradeoffs to consider (as mentioned above) and the effects of these tradeoffs will add to the implications for public finances, going above and beyond the intended effects of the policy (we’re not sure what those are but anyway).

What might happen? In our example, the taxpayer could have any number of borrowing/donation “cap reactions”, all having different implications for public finances. She could decide to make no change in her borrowing and use £40,000 of the total relief for interest payments. Then she could still give the same as before (and make up savings on something else) but that will be more costly after the cap than before since the borrowing choice makes the cap bite on the contributions (the price of borrowing stays the same for this taxpayer but the price of giving goes up). In this case, there will be some loss in revenue for the government on the goods/services that the taxpayer must cut back on in order make up for the loss in after-tax income. The overall effect could be positive or negative.

Alternatively she could decide to give the same after the cap as she did before and use the tax relief of £25,000 against her donations (the price of giving stays the same for this taxpayer but the price of borrowing goes up). In this case, the cap bites on interest relief and it is the borrowing decision that is distorted by the cap. If everyone affected by the cap reduces borrowing as a response to it then there will be implications for public finances through rebound effects on financial markets.

The timing of borrowing and donation decisions might also be affected. A taxpayer affected by the cap might respond by choosing to allocate tax relief to borrowing in the early years of her career and to donations when she is older. This kind of intertemporal distortion could very well affect the entire structure of provision within the sector (e.g., charities currently funded by young people might suffer; those currently favoured by older people might not) and, using arguments analogous to those made above, public finances. But will there be this kind of timing effect? If so, should we worry about it? I don’t know, there is no evidence.

Whatever choices the taxpayer makes, public finances will be affected in unintended ways as the cap will create a chain of interdependent and distortionary changes in donation and borrowing decisions and their timing. But what should we do? The government should scrap the policy, not even discuss it (see my previous post). And everything I’ve said here is speculative so whether or not we should worry about any of it is an empirical matter, we need evidence. But we don’t have it and it is for this reason that everyone – including charities – should care about the cap.

May 06, 2012

Capping tax relief? Say what!?

Writing about web page http://www.thirdsector.co.uk/go/news/article/1129905/government-will-not-move-tax-relief-cap-until-consultation-completed/

The government is proposing to impose a cap on tax relief for charitable contributions. It says that large donors are using the unlimited relief as a way of avoiding taxes. Opponents of the cap say that it will discourage large donors from making contributions and hurt charity. The debate on the proposal has really taken center stage in the media in the last few weeks and shows no sign of abating – there will even be a special Radio 4 broadcast devoted to a discussion of tax relief and charities. And now the government says it won’t do anything about imposing a cap until consultation has taken place.

I don’t know who the government is planning to consult, but the proposed cap falls flat on economic grounds: it is a plan that targets all donors, not just those that may be avoiders; it is not based on clear evidence about the effects of the policy or about avoidance in the first place; and the administrative plan for implementing the policy seems non-existent.

Where is the evidence that some large donors are using charitable contributions as a way of avoiding tax? How big is the problem? Who are these people? If there is avoidance, which part of Gift Aid is relevant – tax relief for capital gains on gifts of property to charity, what? Government is pretty silent on this, but the answers are important. How can any policy be evaluated if we don’t know about the costs and benefits of the problem and its fix?

Well, let’s forget about that – the duck is in the air and we shouldn’t concern ourselves with its takeoff. Suppose avoidance is taking place and it really is a big problem. Then tell us which element of the tax relief system is more vulnerable to being used as a channel to avoid taxes: is it the deduction from tax for cash contributions made by higher rate self assessed taxpayers? or is the avoidance more likely to happen on the relief given for capital gains (very generous)? As all first year economics students know, sound economic policy requires that tax instruments are targeted directly to the problem at hand. Using a generic cap on tax relief to charitable contributions in order to fix tax avoidance is, metaphorically speaking, rather like spraying a room full of people with machine gun fire in hopes of killing a fly on the wall, hardly a rational and efficient way of killing the fly especially when a fly swatter would do the job quite nicely and it wouldn’t kill all the people in the room. It is a bit astonishing that the people formulating public policy in this country seem to have missed that very important point.

Let’s even forget about the lack of targeting. Tell me about the evidence about the effects of the proposed policy. Why should we care about the evidence? Because the policy is designed to improve government finances: increasing revenue and reducing spend on public services. But will it? It all depends on how donors react. Maybe they will react by cutting donations and/or by reducing the amount of taxable income that they earn. Possible? Likely? We will have no idea without some evidence. However, if that happens, donations would fall (which would mean more government spending on public services might be needed) and so might government revenue. I think everyone would agree that implementing a policy that generates such self-inflicted wounds is a bit bonkers.

But we don’t know if there will be self-inflicted wounds such as these. Is there any evidence at all? Hmm … well, maybe there is but nobody in government has told us what it is. Absent some statement to the contrary, it seems that the proposal has been formulated without any evidence – theoretical or empirical – about its possible effects on avoidance and/or donations. In fact, the best available evidence can found in this report, written by myself and my coauthor. There, a very small number of large donors were asked hypothetical questions about how changes in tax relief on donations might change their giving behaviour (some said it would change their behaviour, some said it wouldn’t) and about whether tax relief mattered in their decisions (some said it did and some said it didn’t). This kind of evidence is useful as a starting point, but it is only indicative and not predictive and so should not be used to underpin an ad hoc policy affecting a sector of the economy that receives about £6 billion pounds per year from more than 50% of the population.

Let’s forget the lack of evidence about tax avoidance, the fact that the proposed cap would not only target avoiders but rather all donors, and the fact that there is no evidence base underpinning the possible effects of the policy. Suppose the proposed cap is actually implemented. What then? How would it be administered? I have no idea, and it appears the government doesn’t either since I have not heard a comprehensive statement about it.

So what to make of all of the fuss? I’m afraid that from where I sit the proposed cap on tax relief for charitable contributions does not make a lot of economic sense: it is not a remedy targeted to the problem of tax avoidance; it is not underpinned by theoretical or empirical evidence that would allow us to make a prediction about its effects; and, if it gets that far, I suspect it will be an administrative nightmare to implement. I would really like to have been the proverbial fly-on-the-wall when the good folks at HMRC or the Treasury came up with the plan, although I might have died, either from laughing at the lack of logic or from the spray of bullets.

About me

I am a professor of economics at Warwick University. During the academic year 2015-2016, I am on sabbatical from Warwick and am spending most of my time in London where I am Visiting Professor at the LSE and Visiting Scholar at the National Audit Office.
My research has a broad methodological base, spanning several subfields of economics – political economy, public finance, international trade and finance, industrial organisation – and reaches out to other disciplines where research synergies can be mutually explored – e.g., neuropsychology, marketing, decision sciences. A distinctive theme that runs through many of my research projects is understanding how private behaviour and incentives, as well as government policies, shape the structure, performance and boundaries between the public sector and the non-profit sector – these questions have so far been little studied by academics but they are central to many key policy debates. My research has been published in leading peer-reviewed journals, including general-interest journals such as the Economic Journal, the International Economic Review, and the Review of Economic Studies; and in top field journals such as the Journal of Public Economics and International Tax and Public Finance. It has been funded by the Economic and Social Research Council (ESRC), the Social Sciences and Research Council of Canada, the British Academy, the European Research Council (Marie Curie program), HM Treasury (HMT) and HM Revenue and Customs (HMRC).

My webpage

Here is the link to my webpage, which has more information about my research.

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