Difficult decisions and unintended consequences

One of the 'minor' objectives of government macroeconomic policy is the distribution of income. It's the objective that only really gets significant attention when everything else isn't a worry.  That is probably an indictment of the process.

A report by Saga today points out that some of the biggest losers from recent policy moves has been pensioners.

They have suffered from a cut in the real value of their tax free allowance, low yields on savings and lower pensions to name but three problems.

Saga are a 'vested interest group' of course and so you have to be careful. For example they claim Quantitative Easing (QE) has caused inflation and reduced the purchasing power of pensioner incomes. While inflation does reduce the purchasing power of all incomes I know of know evidence that QE has done anything except prevent a deeper recession.

The distribution of income is important however. The Guardian report shows how averages can deceive us into thinking things are not that bad and reminds us that the costs of economic problems is often concentrated on a few groups.

The Guardian article is here

Tax boob?

VAT is to be applied to cosmetic surgery. The odd thing is that it wasn't before.

VAT is an indirect tax that, by its nature, is regressive (it takes a higher proportion of the income of poor households compared to the rich). The UK has always sought to mitigate the regressive nature of VAT by excluding things such as food, children's clothing, books and newspapers and taxing energy at a lower rate.

So not taxing cosmetic surgery undertaken for reasons of vanity only, that must be the preserve of the rich, seems odd. To my mind this is simply a fair application of the tax.

The problem of indirect taxes, such as VAT,  is that they change relative prices. The price mechanism is the means by which resources are allocated in the market. So when the relative price rises less resources are allocated to that product. Not taxing cosmetic surgery makes it relatively less expensive than goods that do attract VAT, so more resources are devoted to cosmetic surgery than would be in a free market.

Governments can get these things wrong by applying indirect taxes poorly and causing an inefficient allocation of resources. But using indirect taxes to reduce tobacco, alcohol and carbon consumption correct market failures. The important thing is to treat all goods appropriately and try to avoid making the distribution of real income worse. So I think this move should be applauded, although somebody should be asked why it has taken forty years to remove this anomaly.

The Guardian cover the story here