Voting TaKtiX

Hypothecation - not a hypothesis on vacation, but about as much use

My first post on here is something that I’d been planning to write about on my livejournal for a while, but it took me a while (11 months actually) to get around to. The thing that spurred me to actually getting around to write it was someone saying something along the lines of the following:

I wouldn’t mind so much about speed cameras if the fines went towards road safety

And what he’s after is what economists call hypothecation. The problem is, while it might sound good, it’s really quite a bad idea

Here’s the Wikipedia page for it , I’m talking about hypothetical dedication, the second definition used there. It’s not a commonly used words, partly because media shows don’t usually bother to introduce the jargon of the economics they discuss, but mostly because even in economics it doesn’t come up all that much.

As far as I can tell, the main reason why it’s not particularly deeply covered in economics courses is because no-one uses it. Sure there are a few hypothecated small taxes here and there, but it’s never really been used in any big way, because it is of no real practical use. You need to know what it is if you’re an economist though, and the idea behind it. From an academic point of view, once you know that you might as well name it, as that means you can use then that as shorthand when with other people that’ve been taught about it.

Definition in a sentence: A way of assigning the money the government gets from various taxes and charges, sending them back towards the budget areas those taxes and charges come from.

Easy examples would be:

Why people like it

Hypothecation can seem attractive to both the general public and as a result of that it can be attractive to politicians. Why do people like it? Because it seems to make sense, and thus make the government nicking your money ever so slightly less painful. The fact that you’re paying something like £3 or more of taxes to the government every time you buy a pack of cigarettes is easier to deal with when you know that the money will help pay for the treatment you’ll need when you catch something nasty due to your smoking. And as a politician, saying “Yes, I know those cameras give you whopping great fines, but those fines go towards making the roads safer” is a great way to make sure you don’t get voted out next elections.

Why they’re wrong

It’s of no real use, and if taken too far can cause misspending, either too much or too little cash being put into particular parts of the economy.

The problem is that the amount the government should charge will not necessarily relate in any way to the amount you should spend. And that’s because the two are entirely separate - their causes and purposes are different.

The point of most of the different taxes that the government leviesis not to make money - that’s just a happy side effect. Income tax, VAT and possibly a few others are direct moneyearners for paying the bulk of the government’s costs, and there are somethings where the tax or charge is relating directly to the administrative cost of running whatever it is. But for most taxes, the point is to affect people’s behaviour by adding costs to the things in question, so that the quantity consumed/used/whatevered is closer to/at what the government wants it to be, rather than just a function of the cost of the materials and labour versus the demand for the stuff. To quote Jeremy Clarkson (interviewing the minister for transport on Top Gear); the government gets more money from Simon Cowell’s income tax than it does from the combined fines of all the speed cameras in the country. Sure the government likes and makes use of the money that it gets from all the charges, but it could very easily make up that gap if it raised the big taxes by a small amount.

Therefore, the rate at which those taxes are charged is all about how much money you have to charge to affect people’s buying choices. And when many of these things have fairly inelastic demand (big increase in price results in a relatively small decrease in consumption), you need to stick large charges on to have any real effect on the consumption of those things - the best example of this is cigarettes, people are addicted to them, their body demands its fix, and thus you have to raise the price a lot to make them buy less cigarettes. To go back to my examples:

• Road tax is there to make people consider other means of transport than cars,
• Petrol duty is there to reduce the amount people use their cars,
• Speed cameras are there to reduce the amount of speeding, and therefore accidents, that people have.

The amount you need to spend is simply that - the government looks at what needs to be done in each area, decides what it’s priorities are, looks at how much cash it has (and how much it is willing to borrow/print), and then decides how much it will spend on each area. There’s generally no particular reason for that amount to be the same, or indeed anywhere near, the amount that the government decides to charge in that area to affect people’s consumption habits.

And anyway…

When you get right down to it, it’s all money. Apart from the particular wear, tear, and quantity of cocaine that has been snorted through a given £5 note, it doesn’t make much difference what money pays for what. As long as the appropriate quantity of money goes to keeping people alive, repairing the roads, and vaguely trying to make sure we don’t pressure cook the planet, it doesn’t matter if that money comes from road tax, cigarette packets, or the income tax of the prostitute that nearly destroyed Angus Deayton’s career.

Therefore, in my view, there’s no real point to hypothecation - charge what needs to be charged, spend what needs to be spent, and that’s it. As I mentioned before, the risk of hypothecation is that if you decide it’s the way you much go, you’ll get into the situation where you’re spending too much on one area (because there’s a lot of taxed income from it), and/or too little on another (due to lack of tax income in that area).

It sounds nice and logical, and looks good for the voters, but it’s essentially pointless, I feel.

And now I disagree with myself

Albeit briefly, and without changing my actual opinion on the matter.

I can’t post this without mentioning the economic theory that at least somewhat disagrees with the what I’ve written above, though I’ll admit I’m still doing so with my own particular flavour of bias on the matter. The above is my main thoughts on the hypothecation, this is just an added on bit that I remembered from my classes about halfway through. Partly I’m putting this down because I want to be honest and cover all sides of the situation, however it’s also true that this lets me put my argument on this over before someone raises it from the comments box.

Social cost versus private costs are the issue I’m talking about here (warning - complicated and in-depth explanation under the link, I’m giving the simple explanation in the next few sentences). Put simply the private cost of something is everything that a particular thing costs you (including things like damaged health from smoking). Social cost is the cost of whatever it is to the whole of society. Since you’re part of society, the private cost is part of that, but it also includes anything else that doesn’t impinge upon you, but does on other people - passive smoking is a great example - unless you’re of a particularly saintly disposition, it doesn’t cause you any great harm or cost that other people are getting cancer from your smoking, but it certainly costs them! There are also wider issues - the country as a whole benefits greatly from having the vast majority of its workforce fit and well, above and beyond the individual benefits all the people get, thus anything that reduces people’s health reduces that benefit, and is incurring a social cost.

In theory, taxes are used to make the private cost equal the social cost - if your smoking is going to cause other people discomfort and/or lung cancer, or indeed give you a cancer that the NHS will then treat for free, then the taxes are there to take that into account - they’re there to make the amount of those goods that you consume be appropriate to the true cost of the item, rather than just the cost of what it took to make it.

With that as your basis for taxing these sorts of goods, you could argue that if you’re using these taxes to take into account these social costs then all you have to do is put the money from those taxes straight back at the issues that are causing the social costs, and if you’ve got your sums right, the amount you tax will be the same as what you need to put in. Easy as sticking all in Excel and working it out? Unfortunately not. The problem is that:

Firstly, it’s damn hard to work out the true social cost, and often harder to pay them off - things like hospital bills aren’t that hard to include, but how do you quantify the cost of annoying the person who has to put up with your cigarette smoke? Not harming his lungs, but the actual reduction in the fun he has on that night out due to having to be in a smoky atmosphere. Then how do you pay back the poor bastard for the cost he has incurred?

Secondly, the taxes aren’t there just to cover the costs that people wouldn’t themselves pay. They’re also there to stand in for the costs that people will pay, but which they don’t care about enough (for a given value of ‘enough’, of course - it’s the government who gets decide the particular value in this case). Put simply, people don’t put enough value on many things, generally those things that affect the future. The obvious example is the smoker who’s sure he’ll quit aged 35, and his body will heal all the damage up, and it won’t affect his quality of life when he’s old, or indeed the many people that just don’t think about when they’re old (which is incidentally also the reason why the government makes everyone save for their retirement - if they didn’t then too many people would save little or nothing).

The taxes are there so that those costs are at least somewhat taken into account by people when they make their purchasing choices, and so that we don’t have a large proportion of our pensioners starving in the streets. Thus, while it’s certainly something that you need to be aware of when you’re looking into this, the situation is rather more complicated than just trying to raise the private cost till it’s equal to the social cost.

So, that’s my thoughts on the matter. Currently I’m debating what I want to write about next. Mat may suggest something at me, but anyone who’s read this and liked it is more than welcome to suggest something. Have a look at my profile for a description of what I’ve got the knowledge to back up a post on.

January 4th, 2007 Posted by draxar | economics, hypothecation | 5 comments