Piggy in the middle...

As regular readers of this blog will probably have picked up by now I'm not exactly a card carrying Trade Unionist at heart - a considerable understatement perhaps. This isn't to suggest that I don't have a socialist outlook on the world, but more that if over the long term we don't embrace economic competitiveness we will all be broke and hungry. The consequences of competing and winning the economic battle should be that we are even more inclined to help the less fortunate, but never in a way that actually erodes their ability to help themselves.

This view is probably best summarized by the Chinese proverb "Give a man a fish and you will feed him for a day. Teach a man to fish and you will feed him for a lifetime". My approach to judging economic policy is based, therefore, in a form of consequent "sustainable capitalism". So it may surprise some that I did find myself this week reading with interest a recent report ("Life in the Middle" - tuc.org.uk/touchstone/lifeinthemiddle.pdf) from the Trades Union Congress (TUC) in the UK that was looking into the erosion of the status and wealth of "Middle England", or as the Financial Times so patronisingly called the "white van men".

The report shows that income inequality has grown markedly since Thatcher took power in May 1979, to the point where the mean British income now exceeds the median income by some 23%; in 1979 this figure stood at just 7%. This means in effect that a small proportion of earners at the top of the food chain have done relatively well, while the middle masses have seen their incomes and living standards stagnate. As the TUC puts it, Britain has gone from being one of Europe’s most equal societies to one of its most unequal. We’re not referring to the truly dispossessed here, either; rather we’re talking about the millions in the middle, those with a decent job and a mortgage and a pension.

Needless to say, on reading this public report, I thought this would form the backbone of some stereotypical Daily Mail borderline fascist rant. They did not disappoint. "The brave people of middle Britain are now struggling just to survive. Fecklessness is rewarded. Standing on your own two feet is punished" the Mail headlines raged.

As is often the case, the Daily Mail's almost comic levels of ranting often reduces the strength of their point - which every so often they do actual have - a good point that is. While middle Englanders have seen their status erode, they cannot be completely excused of blame. It is this group that created it's own mirage of affluence by taking out levels of personal debt that would have had their grandparents turning in their graves. Moreover, as this group has embraced the benefits of international trade that have brought cheap flat screen TVs, iPods and IKEA furniture they have also seen the things that they make and export erode in competitiveness to the outside world. The manufacturing base that was the driver of British tax revenues in the 60s and 70s has become uncompetitive and uncompelling to the outside world. Middle England doesn't have anything to sell at a price that can sustain their level of spending - in economic language, they are running a considerable current account deficit.

Nonetheless, this should not have meant that Middle England's status should have diminished in relation to the very poor, and the very rich in the country. The important issue that is raised by the TUC report, is that over the past 10-15 years the "engine room" of the (albeit less competitive) British economy has actually had it's status eroded to the benefit of a) government tax revenues, b) very low income earners, or unemployed through New Labour's very expensive tax credits system, c) public services that remain inefficient and overcrowded and d) the very wealthy, who tend to pay the lowest % rates of tax as they choose to receive their "income" in shares which are subject to lower capital gains tax.

While the world was flush with cheap credit, the Middle Englanders that the TUC report refers to felt a false sense of security - a mirage of affluence. As the main home-owning, mortgaged class, house price appreciation more than compensated for the fact that they were effectively paying more tax and getting less back via their public services than they did 30 years ago.

It has been a similar tale in the US. In Autumn of last year the US Census Bureau published figures for median real incomes for US families between 2000-2007. CNN at the time commented that "...this is the first business cycle ever in which the middle class had less income at the end than at the beginning." Median real incomes had actually fallen from $58,500 in 2000 to $56,000 in 2007.

When Karl Marx told the "workers of the world to unite", he was talking about a revolt against the Capitalists. Now the workers should be revolting against their governments, who see them as the ideal group of people to tax - they can pay (or used to be able to), unlike the very poor, and they can't afford good lawyers fees or accountants to help "alleviate" their tax, unlike the very rich. There is something wrong here. The incentives to be that small businessman, or middle manager in this country aren't there any more, so it's questionable where the economic growth is going to come from to pay off the growing debt pile that the UK government is sitting on.

To return to the base concept upon which I write these blogs - this incentive scheme is out of whack. I personally have no issue with inequality of wealth, as long as it is based on principles of wealth creation and not stealth, sleight of hand or fecklessness.

At one end of the scale, New Labour has pandered to the very rich - they run scared when a super high net worth individual claims that they will leave these shores if their tax situation is altered, claiming that their participation in the private equity deals that have led to their ownership of some of Britain's biggest companies is absolutely critical to job creation and the fabled "trickle down" effect of their wealth creation. By and large this is pure manure.

Sadly many of the leveraged buyouts that saw the acquisition of companies suchs as Boots, were debt fueled tax arbitrages that will over the long run destroy wealth and reduce employment. The efficiency gains that were touted as the basis of many leveraged buyouts were smoke and mirrors stuff that covered over the real play. Debt is tax deductible. Profits are taxable. Buy a company, reduce its tax bill by replacing debt with equity, upstream a dividend to yourself and hey presto. Debenhams before being bought by a syndicate of private equity groups paid £40mm in tax, after the leveraged buyout it was paid £8mm by the Inland Revenue on similar earnings. This is not restructuring to create a more efficient business, it's just sleight of hand. The Debenhams situation is in no way unique.

There will always be ways for the well advised to avoid paying taxes, but an incentive structure should be in place to remind the fortunate that the circumstances in society that existed that allowed them to profit - things like a sound legal environment, free markets and solid infrastructure - were paid for by someone, and it is only reasonable that they should contribute proportionately. In the US the super high net worth earners are also the biggest charity givers, not just on a nominal basis, but also in percentage of wealth terms. In the UK, the super high net worths, with a couple of notable exceptions, don't "give back" in any meaningful sense when compared to people of similar status in the US. There is not the same sense of community or societal responsibility.

At the other end of the scale the is the position of the very poor. Gordon Brown's hugely expensive tax credit system, allied with the minimum wage, sharply improved the incomes of the poorest sections of society. Some of those who have been helped by these hand-outs have been thoroughly deserving, but the feckless have benefited as well. There are regular newspaper examples of cases of individuals caught in the "poverty trap", whereby working more is actually less financially beneficial than extracting social security, which is truly the worst form of disincentive structure.

Make no mistake, the UK is in quite a financial pickle. The government plans to borrow £175bn through gilt auctions in the current fiscal year and the same the year after. In last year's budget, public net debt was expected to be 39% of GDP this year, now it is at 59% and is going to be close to 80% by 2013-14. In theory such borrowing should be sustainable if the assets side of the national balance sheet are likely to produce the tax revenues to pay these debts, or if the other part of the liabilities side - public sector spending promises - are reduced, or both. Currently, however, there aren't too many signs as to where the increased economic growth that could afford this debt burden are going to come from.

What is almost certain is that taxes are going to have to rise. The government remains reluctant to really address ways in which they can extract more from the super high net worth population, who continue to threaten to leave these shores if the government moves towards a less lenient approach to their tax position. Crispin Odey, a London hedge fund manager, for example, has regularly suggested that he's "seriously considering leaving". When asked where he would move to, he was quoted as saying "...anywhere else as long as the rivers were stocked with salmon and the valleys with pheasants." Hong Kong Crispin?

At the other end of the wealth spectrum, it won't be the unemployed and feckless picking up the tab either - they'll still be relatively well looked after by the state, because no political party courting the popular vote will risk being seen as a 'benefits slasher'.

The likelihood therefore is that the middle Englanders that the TUC report addresses will be the ones further burdened with increased taxes to foot the bill. While they are not bereft of blame for the position they find themselves in - highly burdened with debt and working in increasingly uncompetitive workplaces - they should not be unduly burdened in the recovery process. But they will be. They are the easiest ones to go after - they can pay, unlike the very poor, and they can't dodge, unlike the very rich.

Now that's not the basis for a sound incentive scheme, is it?