Supply side reform from the Adam Smith Institute

Supply-side reform: Two steps We at the ASI think there are two main areas that are ripe for large supply-side improvements: planning, and the tax system. The UK planning system, and the associated regulatory controls on design, dramatically constrain building such that construction is insufficient, in the wrong place, and of the wrong type, relative to market demand. The UK tax system has undergone many recent improvements but is hampered by a mess of confusing and complicated levies that deter far more in economic activity than is necessary to bring in the revenues the exchequer requires.   Planning A recent paper by Chang-Tai Hsieh and Enrico Moretti, both at the University of Chicago, found that housing supply constraints in the USA drastically constrained worker and firm mobility.[1] According to their calculations, looking at 220 US metropolitan areas from 1964-2009 US GDP, if authorities were able to reduce constraints on housing supply only to the level of the median city, GDP could be 9.5% higher. Output, wages, and living standards could jump around a tenth, that is, if they could only bring everyone’s housing supply restrictions to the middle city. Gains would be substantially higher if every city allowed building like the most liberal city. The restrictions on UK housing supply are substantially tighter than the US median, especially in fast-growing cities like Manchester, Oxford, Cambridge and London. The US, for example, does not have anything as like as restrictive a policy on outward growth as the green belt. Most US cities (except Washington D.C.) do not have height restrictions anything like as extensive of those on certain viewlines in London. And US cities do not require all new buildings to adhere to such stringent light, highway, and access regulations.[2]What’s more, the UK is a highly unequal country; the difference between its highest- and lowest-productivity areas is bigger even than famously divided Italy and post-reunification Germany. Thus, it seems clear that liberalising supply in the UK could bring gains at least as large as those available in the USA. They would accrue only over time, and they would be one-off—they wouldn’t permanently increase the growth rate, but would instead increase the level of GDP (and GDP per capita) for all time. But the gains would still be incredibly large compared to most policy options, and would be very tangible and noticeable to any observer. To a newspaper or tourist or Londoner the change would manifest itself as a huge construction boom—housing and commercial building starts at levels not seen since the 1920s. This would start slowly, as firms built up capacity, but rapidly speed up. Rent growth would stall, then rents would begin to fall. The investment component of house prices would fall immediately, accounting for the large increase in housing supply. Populations and densities would grow rapidly in economically dynamic cities, making mass transport more efficient and viable across the cities, not to mention all other sorts of businesses: cafés, shops, restaurants, pubs, clubs, bars and service industries. There would be income effects across the spectrum. Loosening housing supply could be done in three main ways: type, location, and height.   The London code, and other regulatory restrictions on building designs, could be loosened to allow more popular ways of building densely (like the terraces of Islington, Pimlico, Kensington, Chelsea and parts of Brixton). Some areas of the Green Belt could be opened for construction—perhaps the 3.7% of the London Green Belt that’s within 10 minutes walk of existing transport infrastructure. This could be built densely in a popular way, rather than purely being made up of executive detached houses. And certain areas of London—clusters, like the planned cluster around the American Embassy at Nine Elms/Vauxhall—could allow higher buildings. On top of that, there could be a much easier system for obtaining planning permission to increase the height of existing two or three story buildings to four or five or six storeys. Trillions of property value could be created on top of the £1.7 trillion there already is in London. The countervailing consideration of congestion is a serious one, and one that should not be ignored. But its costs can be mitigated straightforwardly, since the gains are so large. More bus services, tubes and trains can be run in London; the congestion charge can be hiked to take account of the greater scarcity of the roads. The alternative is essentially a noose around London’s—and other growing cities’—necks, holding their success back. For more information, see our reports The Green Noose and A Garden of One's Own.   The tax system Outside of impossible or improbable lump-sum taxation systems like taxes based on height, innate ability, or simply existence, and a small range of Pigovian taxes on externalities, there are no taxes which do not cause deadweight losses. That is, there are no real world taxes which simply move money around, without reducing economic activity at the same time. Once we’ve collected the revenue of well-designed congestion charges, fuel taxes, alcohol and smoking levies, and carbon taxes, we are always going to have to reduce economic welfare when we tax (even if we increase welfare overall by spending that money well). But that doesn’t mean that every way we raise our £700bn is equivalent. Some taxes are costlier than others. Consider a consumption tax of some percentage on every good and service as a baseline. This reduces everyone’s buying power, and it distorts activity, since it makes every good more expensive with the exception of leisure, which is now cheaper (since every £1 of pay, and hence every hour of work, can buy less in goods). But other than that, it is neutral between different goods: everyone still spends their budget in the same proportion as they would do in the no-tax world. And everyone saves the same fraction of their budget as they would in the no-tax world. Now consider a world with an income tax. In that world you pay tax not only on the fraction of your income you consume, but also on that fraction you save. Since this both reduces the principal upon which you earn interest, and the interest itself, directly, this makes future consumption more expensive, and saving (which provides the funds for investment) less attractive. In this world, not only do people do fewer hours and produce less output because consumption is more expensive, work is less well paid, and leisure is cheaper, but people also invest less, reducing future living standards.[3] According to plausible estimates from Nobelist economist Bob Lucas, the gains of scrapping all taxes on capital could be greater than those of eliminating the business cycle.[4] Generally, economists have concluded that tax systems are best when they rely more heavily on consumption taxes, and rely less on taxes that fall on capital or transactions.[5] Great efficiencies could be obtained within the UK system without reducing revenues, including:   Broadening the base of VAT to eliminate all exemptions and rate reductions—it would bring in £30bn, which could be used to eliminate less efficient levies, and compensate those who’d lose out (VAT is mildly regressive when considered within one year, and mildly progressive over the lifecycle) Scrapping stamp duty both on housing and on shares—the former reduces the efficiency of the housing market hugely, and makes housing shortages much costlier, since people are much more reluctant and less likely to move (as it costs so much more); the latter would raise the efficiency and information content of financial market prices, and make raising capital much cheaper (the tax ripples through the system, even though the rate is small in an absolute way) Merging employer NICs, employee NICs, and income tax, raise the thresholds to the income tax level—all of these, whoever hands them over, fall on the worker, and raising the threshold will deliver incentive-boosting income gains to those who need it most; clarity and simplicity are both desirable in a tax system as well Merge council tax and business rates, charge them at the same level, and charge them on unimproved land values—with modern econometric techniques, this is a technically trivial question; economically, there is no reason at all to subsidise one kind of land use, especially since the subsidy seems, in empirical work, to go to the landowner not the tenant (business or household)   [1] Hsieh, Chang-Tai, and Enrico Moretti. Why do cities matter? Local growth and aggregate growth. No. w21154. National Bureau of Economic Research, 2015. [2] Smith, Nicholas Boys, and Alex Morton. Create Streets: Not just multi-storey estates. 2013. [3] Feldstein, Martin. The effect of taxes on efficiency and growth. No. w12201. National Bureau of Economic Research, 2006. [4] Lucas, Robert E. "Supply-side economics: An analytical review." Oxford economic papers 42, no. 2 (1990): 293-316. [5] Mankiw, N. Gregory, Matthew Weinzierl, and Danny Yagan. Optimal taxation in theory and practice. No. w15071. National Bureau of Economic Research, 2009. Harvard