I was asked yesterday about why I am using HMRC aggregate data to estimate the impact of the tax proposals that I am making in the Taxing Wealth Report 2024.
The person asking suggested that I should, instead, be using micro simulations, i.e. economic models. This, they suggested, is the approach used by the IFS, the Resolution Foundation, Compass, and many other organisations who look at some of the issues I am addressing. I am well aware, for example, that is the approach used by Howard Reed, who comments on this site and whose work I much appreciate.
In that case, let me be clear that I do not have a problem with people using microsimulation data. It is an accepted technique, and the data that is used for this purpose is based upon ONS household surveys, which are considered to be statistically valid, although there are always reasonable questions to ask with regard to selection bias whenever they are used.
However, as an accountant and auditor, rather than as an economist on this occasion, I am always inclined to use available aggregate data rather than produce a simulation based upon a survey. The reasons are obvious to me.
Suppose, as an auditor, I have to choose two approaches to verifying data. Suppose that I was trying to establish the figure for sales for a company. Which technique would I prefer? Would I prefer to go to the company's books and records, from which I can extract a figure for aggregate sales which I can then test for credibility and completeness, or would I rather do a survey, asking people whether they have bought from the company, and then extrapolate total potential sales from that? I think I can tell you which one is the accepted audit technique. I can also confirm that only one of those would pass scrutiny if the quality of an audit was being reviewed.
Saying that, I wholly accept that there are problems with aggregate data. One of those is that HM Revenue & Customs is sometimes inconsistent with regard to the information it publishes, because revisions are not unknown. That is why I use the most recent verified data in some cases rather than more recent estimated data. I am seeking the most reliable data source that I can, even if it is older as a consequence.
Another problem with this information is with regard to stratification. Sometimes the data is simply not stratified in the way that I would wish. I accept that problem because it is real. However, it is usually not very difficult to estimate data points within the available information to approximate the stratification that is required. So long as caution is used, I think that this is acceptable.
Then there is the obvious problem of behavioural responses, but this is absolutely the same with microsimulation techniques. Why that methodology should better estimate a behavioural response then I can, I do not know. In both cases, the person creating the tool is expressing their opinion on what people might most commonly do in response to a tax change. I explicitly mention my own assumptions on this in every one of the notes that I produce so that no one can miss the issue.
Some of the suggestions I make on behavioural responses may be countercultural to many people. For example, I suggest that many people who are asked to pay more tax work more, rather than less, as a result, although microeconomic theory would usually suggest otherwise. However, microeconomics can be wrong. The reality is that many people live in a world where they have very strong fixed financial commitments, so tax increase requires them to work more, whatever microeconomic theory says.
In other cases, I suggest that although a change might be significant, it will produce very little behavioural response because the structure of society does not really permit that. For example, tax relief on pensions might change, but if contractually a person is obliged to commit to pay a fix percentage of their salary in pension contribution then that is what they will still do so, in most cases. as a consequence. As a result, I very often suggest that the behavioural response to what I am suggesting will be small because that is what a reasonable appraisal of the evidence suggests.
Thirdly with regard to aggregate data, by providing links to the data that I use from HMRC and elsewhere, what I hope I provide is an opportunity for someone to have a go at creating their own estimate if they do not like mine. I usually find that very difficult when looking at microsimulation data.
Finally with regard to aggregate data, it is available for all the many taxes I am looking at, whereas data to allow microsimulation on many of them on a reliable is not, in my opinion. As a result, I am using aggregate data to be consistent throughout the work, which I think is very important.
What I stress is that none of this implies that I think that I am necessarily right when making forecasts. I am presenting estimates. I do not claim that they will be anything more than that. But that is the best that anyone can do. By suggesting that there is an opportunity for someone to have another go and come up with another answer, I hope that I am making clear my own fallibility, or at least subjectivity. That is inherent in all work of this sort: when assumptions change with regard to forecasts, so do the resulting answers.
Overall, I have one objective, and that is to provide an indication of the consequences of plausible changes. Absolutely, no one can say such indications are right, and I do not. But, making such forecasts is a normal part of the life of an accountant or an economist, and so it is an entirely reasonable thing to do, so long as it is understood that the suggestion is based upon plausible, verifiable data, to which reasonable assumptions have been applied, and reasonable behavioural responses have been considered.
Over the whole range of work that I am doing in the Taxing Wealth Report 2024 the use of aggregate data best lets me make the forecasts that I want to present. I will be sticking with my methodology.
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is this in response to Dan niedle’s tweet?
Ni
I have not seen his tweet
I will look now
Tax is one factor; not always the most problematic. What is problematic is the issue of neoliberal ideology, combined with established Conservative financial incompetence (the polite word). Here is the Public Accounts Committee (PAC) judgement of the PPE issue during the pandemic, on which you blogged often enough in outrage, and I certainly commented often enough here with the same sense of stupefaction that the British people would not only allow it to happen, but that the same level of government inadequacy continues today.
The PAC “found the Department of Health and Social Care wasted an ‘extraordinary’ £14.9bn on PPE and related COVID expenditure across the last two years. No one could predict the COVID-19 pandemic, but we could have been better prepared,” the report said. The scale of the losses incurred in a panic response on issues such as PPE procurement are documented in this report. We need to learn the lesson that there is always unpredictability.” (Sky News)
£14.9Bn blown irresponsibly on PPE. This was the direct effect of neoliberal austerity (where rigorous financial control would have required properly managed long-term expenditure, not withdrawing it – which merely compounds the scale of loss), plus ignorant market-obsessed ideology, plus downright Conservative incompetence.
For example only; before austerity Britain had £1Bn of emergency PPE in store – for a pandemic. Conservative austerity from 2010 meant that when the stored PPE was called on, it was all out-of-date and unusable because a casualty of austerity. There is Conservative neoliberalism in a nutshell.
£15Bn lost on just one act of utter stupidity; one of many.
The Conservative Party does not deserve to survive, never mind for a Government.
Thank you for your hard work on all this. I suspect it is even more work than one would first think.
Whilst one might wish to make more complicated tax changes I think I understand what you are trying to do (though it would not hurt to restate it). If I’m right you are looking to make simple changes of only one aspect of the tax system, rather than multiple simultaneous changes (that is, for example, changing only NI or income tax, but not both by, for example combining them into one composite tax). I think this is very valuable.
You say:
“I suggest that many people who are asked to pay more tax work more, rather than less, as a result, although microeconomic theory would usually suggest otherwise”
Thank you for making this entirely reasonable assumption, though it does run counter to the neoliberal narrative. That narrative says that we should cut benefits, or not increase minimum wage (for example), because that will incentivise the poor to work harder. But, at the other end of the income scale, that same neoliberal narrative says that we should reduce taxes on the rich to incentivise them to work harder. That is wholly inconsistent. You can’t reasonably claim that both reducing income and increasing income both incentivise harder work.
I think you have got this much more correct. Reducing income incentivises people to try to work harder at both ends of the income scale. But it is cruel and pernicious to apply it to people at the very lowest income levels because, in general, they are not able to increase their income; they already have every incentive do so, would if they could, and making them poorer won’t make it happen.
Thanks again.
My aim is to present a smorgasbord of changes that could be used individually or be combined by a government seeking additional revenue if they thought it appropriate – as I think they are bound to do soon.
Thanks for other comments.
When I was younger I was bemused that the poor needed the threat of poverty to make them work harder, whereas the rich needed an incentive of more money to do the same.
Then I realised who was making the suggestion,
Mr Kent,
Your point about what is essentially the ‘paradox of incentives’ in neoliberalism is extremely well made. The underlying problem is that economists (ironically failing to follow the philosopher, Adam Smith) have casualised psychology, having borrowed long exploded behaviourist ideas, and failing to develop their knowledge (the world passed them by): and therefore they have no understanding whatsoever of human psychology. This is problematic, because economics is essentially a psychological activity.
“Some of the suggestions I make on behavioural responses may be countercultural to many people. For example, I suggest that many people who are asked to pay more tax work more, rather than less, as a result, although microeconomic theory would usually suggest otherwise. However, microeconomics can be wrong. The reality is that many people live in a world where they have very strong fixed financial commitments, so tax increase requires them to work more, whatever microeconomic theory says.”
Microeconomic theory says that there are two interacting effects. The income effect – taxes have risen, I need to work more hours in order to make my nut before I go off fishing – and the substitution effect – taxes are what? Bugger work, I’m off fishing.
The labour supply response to a change in taxes is the aggregate of those two effects. Theere are entire libraries full of empirical work – that is, not theory but observation – estimating who is subject to which and how much.
The general finding being that the low paid on piecework go for the make my nut response, the high paid the buggerit millennium hand and shrimp. This is observation, noting what homo sapiens sapiens tends to do, not theory. The aggregate effects simply are that – for of course there are individual exceptions to everything we say about human behaviour.
I am saying I see no evidence in reality of that top end effect for the reasons I note
Candidly, I do not believe the studies, extreme cases apart, which is of course what they look at
It’s called selection bias
For nearly as long as I have heard politicians and businessmen pontificating that people are more productive if they are paid more or taxed less, I have been aware of the many studies that demonstrate that this is not true.
While examining the problem from several different angles they all tend to conclude that as far as pay is concerned most people believe in what could be called the a-fair-days-pay-for-a-fair-days-work concept of payment. Beyond that more money had little power to motivate
As far as motivation was concerned they found and I am simplifying greatly, people are motivated by being part of an intelligent respectful organisation that treats them like human beings.
The idea that workers are motivated by money falls into that category of ideas to which JK Galbraith referred when he said, “When ever I hear a businessman talking about common sense he is usually talking about the ideas of some long discredited economist”
Galbraith was right
So are you
Seriously, do you really think that a CEO, on say £5million/annum will really throw in the towel and retire because he’s asked to pay, even quite a lot, more tax? Or that a premiership football player will stop playing football?
What about the single parent struggling to hold down two low wage jobs to feed an clothe their family. If you cut benefits are they really going to be able to work even more? Sure,the inventive might be there, but their ability to act on it is not.
Really, if you believe either of these things you are not living on the same planet as I am.
Well said, Tim.
“libraries full of empirical work”.
None of which, you actually cite.
I think survey-based microsimulation and estimates based on aggregate data are both useful. Both approaches have their pros and cons.
With survey data it’s easier to do distributional analysis and the granularity of survey data makes it easier to model a range of reforms to the current tax system. However surveys can have drawbacks:
1) sometimes representativeness (the extent to which the sample represents the UK population) is a problem due to non-response – which is particularly a problem for very rich/wealthy households, or when the survey is quite onerous (for example the Living Costs and Food Survey, which is the main source of household-level consumption data in the UK, only has a response rate of between 50% and 60%. The ONS corrects for non-response using weighting factors but this approach is not always 100% effective.
2) microsimulation approaches which account for behavioural change are inherently difficult to implement (although not impossible).
3) survey evidence on certain components of the tax base (in particular capital gains tax for individuals, and taxes for companies) is relatively poor in the UK.
In my work I tend to use a mixture of microsimulation and aggregate approaches. In particular, I’ve found approaches which calibrate policy costings derived from survey data to aggregate data from HMRC or ONS to be very useful.
Thanks Howard
Appreciated.
I think we agree.
Microsimulation. Simulation. The name tells you what you need to know. simulation is a substitute for fact. It is used because the access to and understanding of the facts are difficult to obtain, or interpret. You are right Richard to express the reservation of an accountant over the empirical dilettantism of economists. Stick to your guns. They are wrong, and so is conventional wisdom; and that is a fact.
John
Simulation has its uses
But in this case I do not think I need it
So, I will be sticking to my guns
Richard