Unpleasant choices

Funds are needed to reform the social care system …

Fiscal strategies around the world have been blown off course by the pandemic which has forced governments to reconsider ways to pay for the demands on the public sector. Indeed, one consequence of the pandemic is that it has highlighted the need for a strong public sector to marshal the resources required to meet unprecedented circumstances. It has also highlighted the need to fund areas of public sector engagement which have been neglected for too long.

One such issue in the UK is the provision of social care. Scarcely a week goes by without news that one of yesteryear’s footballers has been diagnosed with some form of dementia – a particularly distressing condition which robs people of their identity – with the latest victim being former Liverpool and England footballer Terry McDermott. Whilst professional footballers appear particularly prone to the disease, due to the repeated application of blows to the head as a result of heading the ball, it affects many hundreds of thousands of people in the UK alone. According to the NHS, there are more than 850,000 sufferers, with 1 in 6 aged over 80 afflicted. Social services struggle to provide the requisite care for this and other conditions, and upon acceding to office in July 2019 Boris Johnson promised to “fix the crisis in social care once and for all with a clear plan we have prepared.”

It turns out that the “clear plan” did not exist. But the Conservatives did promise in their 2019 election manifesto to “build a cross-party consensus to bring forward an answer that solves the problem.” Unfortunately Covid blew the government off course but as we start to cautiously look ahead to the post-pandemic world it appears to be seriously considering how to tackle the issue. Media chatter in recent days has focused on the likelihood that the government will announce a rise in National Insurance Contributions (NICs) – a form of payroll tax – to fund it. It is being suggested that both employers and employees will pay an additional one percentage point, which it is estimated will generate an additional £10bn of revenue (around 0.5% of GDP). One problem with this policy prescription is that it flies in the face of the 2019 manifesto commitment that “we will not raise the rate of income tax, VAT or National Insurance.”

This was, as I noted 2019, “not good policymaking” because “taking these key levers out of the fiscal equation could severely limit the Chancellor’s room for manoeuvre” – a lesson amplified by the unexpected nature of the Covid pandemic. Nonetheless, whilst the plan to raise taxes has been widely criticised as a break with the manifesto commitment, there has been rather less acknowledgement of the fact that it is designed to fulfil another one. That there is a need to provide additional funding for the social care system is undeniable. As the Kings Fund has pointed out, the one percentage point rise in NICs back in 2003 to fund the NHS resulted in “a generational improvement in waiting lists, major investments in key causes of death such as cancer and heart disease, and improvements in mental health.” Providing the funds alone is not enough and significant reforms to the system are also required. Nonetheless it would represent a good start.

… but NICs are not the best way to raise them

The planned tax rise has also come in for significant criticism for a number of economic reasons. For one thing, it is a tax on those in employment whereas those of retirement age are the prime beneficiaries which strikes many people as unfair. It also comes at a time when the government is planning to phase out the temporary increase in Universal Credit to help low paid workers during the pandemic. According to one MP quoted by Sky News, “I'm very concerned about the fact we seem to be protecting the inheritances of those with means at the same time as stripping the £20 uplift [in Universal Credit].”

NICs are also regressive. All employee income between the lower earnings limit (£9,568 per year) and upper earnings limit (£50,270) is taxed at a 12% rate but any income exceeding the UEL is subject only to a 2% rate. This has the effect that the average rate of National Insurance Contributions falls the further incomes are above the UEL. Thus, whilst those earning £50k per annum pay an NIC rate of 9.7%, those earning gross income of £100k pay an average rate of 5.9%. Even more egregious is the fact that those earning half the average wage (around £15k per year) pay a higher NIC rate than those earning £200k. If the government is intent on raising NIC rates, it really ought to review the structure of the tax first. It could, for example, raise the tax rate applied above the UEL so that the average tax rate falls more slowly at higher earnings levels (see chart 1 demonstrating the impact of various options).

Another problem with hiking NICs is that the incidence will also fall on employers. The empirical evidence does not suggest that hikes in employer NICs will have a significant impact on employment but it may at the margin impact on firms’ willingness to create new jobs, particularly in the post-Covid environment where many service sector firms face uncertain revenue prospects.

It is not even clear why we need NICs at all. They were originally intended as a tax to fund the social welfare system but they have long since been subsumed into general taxation (only around 20% goes directly to the NHS). In effect, they are perceived as a form of income tax. Some years ago I performed some calculations which suggested that it would be possible to abolish NICs altogether and set higher rates of income tax whilst still giving a post-tax income boost to the lowest earners. In my view this would not be a bad place to start in order to reform the tax system – a subject to which I will undoubtedly return.

What are the alternatives?

One possibility is a rise in income taxes. As the IFS has pointed out an increase of 1.5 percentage points in the basic and higher rates of tax could generate the same revenue as the proposed rise in NICs. The incidence of the tax is also skewed more to older workers, with 14% of the revenue coming from pensioners versus 1% in the case of NICs – not a huge amount but it is an improvement. However, an increase in income taxes would also violate the manifesto commitment.

Unions have suggested that capital gains taxes be increased although according to the HMRC ready reckoner, each one percentage point increase across the board would only generate around £175 million. A rise in CGT rates would go a long way as a signal of intent to the low paid, but as a practical revenue raising measure it would not deliver much. Increases in stamp duty land taxes by one percentage point could generate around £1 billion. But this is only 10% of the yield generated by higher NICs, so here too, a significant hike would be required to make up the shortfall. It would thus appear that an alternative to hiking NICs would require a combination of tax increases across a variety of areas. For example, a two percentage point rise in stamp duty plus a five percentage point increase in CGT would yield £3 billion. Another £1 billion could be squeezed out of inheritance taxes whilst a 4 percentage point rise in the additional NIC rate (paid by those earning more than £50k) would yield £4.6 billion (chart 2).

However, it is unlikely that a Conservative government would be willing to sanction higher taxes on capital and the well-paid. Ultimately, however, they may have little choice in the long-run and I maintain that a discussion about some form of wealth tax is one which the electorate needs to have. Income taxes exist in part to address the problem of income inequality. But with official statistics suggesting that the richest 10% of UK households hold 44% of all wealth whilst the poorest 50% own just 9% it is a problem that, like it or not, our society needs to address.

The case for normative economics

The epithet dismal science is often used to dismiss economics and its practitioners. This is unfair in many respects. Those who think economics is dismal are advised to have a look at Kilkenomics, the world’s first economics and comedy festival which celebrated its tenth anniversary in 2019. As for whether it’s a science, the jury is still out.

If we define science as what Ernest Nagel called the search for “repeatable patterns of dependence”, (here, p4) then economics could indeed be classed as a science. But if we define it as a reliance on experimental method, Robert Heilbroner suggests that this “throws into limbo certain central ideas of economics, such as value or utility, for which no experiments seem to be possible”.  Since Heilbroner wrote these words almost 50 years ago, there has been a considerable amount of progress in experimentally testing some of these central economic hypotheses, thanks to the work of people like Daniel Kahneman, who has applied psychological techniques to key economic concepts. But still the debate rages.

The moral dimension

I raise this question because it throws up an important issue: that of value judgement in economics. A discipline which pursues the cold hard logic of the physical sciences has no room to make moral judgements. But one of the pioneers in the field of economics was Adam Smith, who in 1759 wrote a book titled The Theory of Moral Sentiments. As titles go, that is as far away from value free economics as you can imagine. More importantly, it provided the ethical, philosophical, psychological, and methodological underpinnings for Smith's later work such as The Wealth of Nations which is now regarded as the first great work in western economics.

Over time, economics moved away from its philosophical roots and by the 1930s, neoclassical economists argued that since the notions of utility and culture which underpin economics are difficult to measure, we should simply avoid them. Rational choice theory, pioneered by Lionel Robbins, postulated that individuals perform a cost-benefit analysis to determine whether to pursue a particular course of action – a way of thinking that quickly came to dominate mainstream thinking. However, rational choice theory could never explain why individuals undertake actions that appeared not to yield any direct benefit to them, such as charitable giving. But by the time economists began to understand that a whole range of cultural factors determined why individuals took a particular course of action, so entrenched was the culture of positivism that it became increasingly difficult to challenge the status quo.

Whilst economics has gone to great lengths to sidestep the moral issues which its analysis throws up, as Timothy Taylor put it “moral judgments aren’t willing to sidestep economics.” As he points out, economics starts to get into difficulties when it becomes subject to “mission creep”. At the heart of the problem is the reliance on the price mechanism to assign value to a particular activity. But this quickly falls down when valuing an activity which is deemed ethically dubious or where the price mechanism is simply not the appropriate tool.

I have often thought that this reliance represents a form of economic singularity – the point at which conventional laws break down. Indeed, my own reservations stem back to my undergraduate days when I was taught that the cost benefit analysis of health programmes was based upon the value of human capital defined on the basis of lifetime earnings. This never struck me as sensible. I later came to realise that the relevant metric is willingness to pay to avoid particular outcomes – a cost that could potentially become infinite in order to avoid the worst-case outcomes. It is precisely because of such calculations that I have been rather scathing over the years about the field of health economics which takes a very narrow cost-benefit approach to one of the most fundamental issues we face – the matter of life and death itself (in fairness, it has moved in the direction of willingness to pay analysis in recent years, thus mitigating part of my criticism).

Why this matters

The issue of ethics in economics is an important one. Policy cannot be framed without some reference to what society deems morally acceptable. It is simply not enough to adopt a positivist approach. In macro terms we can debate the righteousness of the guiding principles followed by the Reagan and Thatcher governments of the 1980s but they were at least coherent: They were designed to reduce the role of state interference in the lives of ordinary citizens and empower the individual. In other words, there was a normative element to the policy. As it happens, they focused on a very narrow set of criteria which boosted short-term material prosperity but failed to take account of the wider long-term costs (rising inequality and the hollowing out of the industrial base to name but two). Nonetheless, the ideas were so electorally popular that subsequent generations of politicians on the other side of the political divide (Clinton/Obama and Blair/Brown) did not try to reverse the tide and instead tried to marry it with the idea of promoting social justice.

In recent years neither the US nor UK policy agenda appear to have been guided by any form of coherent economic thinking. Starting in 2010, the British government adopted a positivist approach based around deficit reduction but this had significant adverse consequences for the less well-off members of society and played a big role in whipping up the discontent which ultimately led to the Brexit vote. The populist governments which emerged post-2016, notably those led by Trump and Johnson, do not appear to offer any coherent economic vision at all.

Trump’s economic policy was based around an America first philosophy which served only to trash the global rules-based order and lit the touchpaper for the disaster which has unfolded in Afghanistan in recent days. Even leaving this catastrophe aside, pursuing what amounts to an isolationist stance in an increasingly interconnected world makes little sense as an economic strategy. The Johnson government has followed a similar stance in that it has trashed the UK’s relationships with its erstwhile European partners. But the criticism most frequently levelled at the Johnson government is that its policies are opportunistic rather than aimed at a coherent set of normative goals. There are some elements of a moral economic policy – notably the promise to “level up” regional inequalities – but over the last year its actions have created an impression that it is out to secure the interests of its members rather than the electorate it is meant to serve. Moreover, in areas such as NHS reform and defence spending – both of which are driven by economic considerations – there is no sense of a coherent, principled approach.

All this gives economics a bad rap, partly because politicians tend to blur the lines between complex economic issues and simple budgetary concerns. Economic policy should concern itself with the wider implications of its actions rather than focusing merely on the monetary aspects. Whether or not people think of economics as a science matters less than the fact that it has roots which emerge from its philosophical traditions, and we would do well to remember that sometimes we have to think in terms of more than assigning monetary values to policy objectives. Adam Smith would undoubtedly have approved.

Faster, higher, costlier

Even as a big fan of athletics I must confess to ambivalence ahead of the Olympic Games, being unsure of the wisdom of them taking place when the vast majority of Japanese did not believe they should go ahead this year. In the event they provided a welcome distraction with a number of great track performances to whet the appetite (world record performances in the men’s and women’s 400m hurdles being particular highlights). Technologically, broadcasters met the challenge of delivering the games superbly. The BBC, for example, which usually sends large teams of reporters out to the host city, managed to cover the games from its studio in Salford (5865 miles or 9466km from Tokyo) and if they had not told us, we may not have been any the wiser.

The Olympic legacy: A big bill

Now that the Games are behind us, many of us will miss waking up to our daily fix of Olympics news. But as the Olympic juggernaut moves on to Paris in three years’ time, spare a thought for the good people of Tokyo who will be left with the costs of dealing with an event which comes with a considerable bill attached. According to Bent Flyvbjerg and his co-authors who have looked at all Olympic Games (winter and summer) since 1960, “at 156 percent in real terms, the Olympics have the highest average cost overrun of any type of mega-project. Moreover, cost overrun is found in all Games, without exception; for no other type of mega-project is this the case” (see chart below). The 1976 Olympics, held in Montreal, resulted in a cost overrun of 720% relative to budget and saddled the city with huge debts for the next 30 years. Not for nothing was the Olympic Stadium nicknamed "the Big Owe".

Tokyo is living down to these expectations. According to Victor Matheson and Andrew Zimbalist, “Tokyo was awarded the hosting rights in 2013 with a bid of $7.3 billion. Yet a government audit has shown the total cost to approach $30 billion.” Even allowing for a $1.3 billion defrayment contribution from the International Olympic Committee (IOC), that is a serious cost overrun. Matheson and Zimbalist reckon that around $3 billion of the cost overrun can be attributed to Covid-related expenditure.

In order to estimate the net financial position we need to take account of revenue where the pandemic has had a significant impact. Not that the host city ever gets a fair slice of any revenue, even in the good times, since the IOC creams off most of the TV revenue and gives only a small proportion back to the host (chart below). Consequently, the host bears most of the financial risk associated with staging the Games whilst the IOC generally gets most of the benefits (the same is true of World Cups, where FIFA takes the largest slice of the revenue). This time around matters were complicated by the enforced absence of spectators which resulted in around $800 million of lost ticket sales whilst it is estimated that Tokyo lost out on $2 billion of associated tourist revenue.

Adding together the Covid-related costs and revenues implies a hit to the bottom line of around $6 billion (almost as much as the event was scheduled to cost when the bid was first submitted in 2013). But even stripping out these special factors, the underlying cost of the Games is almost $23 billion – a 215% increase over the original budget. Incidentally, it is reported that had the Games been cancelled, the IOC would have had to refund $4 billion to its broadcast partners. Unless there are other penalty clauses in the agreement between the organising committee and the IOC, it would have been cheaper for Tokyo to refuse to hold the games than incur the Covid-related hit.

Reform of the process is clearly needed

Questions have been raised over the years as to whether the current model, in which a new host city is chosen every four years, is sustainable. The Tokyo experience has raised these questions to a new level, particularly with regard to the fiscal costs of supporting the economy in the wake of the pandemic, not to mention environmental concerns. This is not to deny that hosting an Olympics is a fun event – the 2012 Games in London will live long in the memory of those who experienced them. But cities are increasingly unwilling to bear the financial costs of acting as host. Boston, Budapest, Hamburg and Rome all withdrew their bids for the 2024 Games, leaving the field clear for Paris, whilst in an unprecedented action the 2028 event was awarded to Los Angeles without even making a call for other bidders.

History records that the LA Games in 1984 were the only one in modern times to make a profit. This was achieved because the organisers were able to leverage off existing infrastructure rather than create all the facilities anew which is where the problems lie. The cost problem is exacerbated by the fact that, to quote Matheson and Zimbalist, “a winning bid not only needs to show how the host will successfully manage the competition … but also how it will generate more amenities, more prestige, and more revenue to the IOC than any other competing bid, leading to an arms race where proposals are increasingly lavish and increasingly expensive.” But despite the claims made by all organising committees that the Olympics will act as a useful economic regeneration exercise, the reality is rather different. As Stephen Billings and Scott Holladay argued in a 2011 paper, “proponents argue that this investment will pay off through increased economic growth, but research confirming these claims is lacking.”

One of the selling points of the 2012 Games in London were the legacy aspects. Whether or not these have been delivered remains a point of contention even to this day. Similarly, investment for the 2016 event in Rio was justified on the basis of its impact on regenerating the local community. This has clearly not been delivered. Organising committees also like to highlight the tourism benefits and here, too, the evidence is mixed. Following the 1992 Olympics, Barcelona did rise from eleventh to the sixth most popular destination in Europe but London in 2012 received fewer tourists than expected as security concerns and expectations of overcrowding dissuaded a lot of potential visitors.

The evidence thus suggests that the direct benefits of hosting the Olympics are dubious at best and possibly non-existent. So why do countries want to put themselves through the ordeal? The one-word answer is simply “prestige.” However, democratic countries facing budgetary constraints may be less willing in future to step up to the plate but those with a less robust democratic tradition may be more willing to do so since fewer questions will be asked about the finances. In recognition of the fact that the field of potential bidders may narrow in future, the IOC has proposed to evaluate bids based on economic and environmental sustainability, which is a good start. Given the difficulties in judging costs and benefits ex ante, a more sensible idea may be for the IOC to choose a permanent site, thus lowering the long-term costs of holding the Games. In the event that this proves too controversial, it may consider a small number of sites based in cities (or regions) which already have a substantial amount of infrastructure in place, opening up the prospect of a rerun of London 2012 or Tokyo 2021 in the not-too-distant future.

As a sports fan who appreciates the significance of the Olympics and its impact in bringing people together, I am much in favour of continuing in the present vein. But they cannot be allowed to continue at any price. At a time when the world is acutely aware of environmental considerations there is a strong case for reining in the costs. It may be too late for the residents of Tokyo, but Parisians take note. It’s your turn next.