As Frederic Bastiat famously wrote:
There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.
Regarding Labour’s education tax, economists ‘confined themselves to the visible effect’: shifting children from the private sector to the state sector does indeed cost taxpayers money. This is confirmed both by the Institute for Fiscal Studies (IFS) whose evidence is the only supportive review for the tax, and by the economists at the Treasury who produced the Government’s impact assessment.
Neither set of economists explored ‘those effects that must be foreseen’. They are silent on the large, and obvious, related-market risk to feepayers’ labour supply, and the equally obvious supply-side risks to the £5.1 billion of tax revenues and 328,000 jobs dependent on the sector. These omissions, both covered in detail by the Adam Smith Institute, substantially detract from the fiscal case for the tax, and also the Government’s raison d’être: kickstarting growth.
Both the IFS and Government also fail to foresee the effect on market dynamics: choice and competition. This detracts from another of the Government’s missions: breaking down barriers to opportunity. Today’s article explains why.
We can turn to another Bastiat quote:
The most urgent necessity is, not that the state should teach, but that it should allow education. All monopolies are detestable, but the worst of all is the monopoly of education.
Choice
Choice enables diverse customers to obtain their diverse needs. Diversity allows innovation and improvement. For a merit good such as education, there is social as well as private benefit when customers can gain better outcomes via choice.
Human rights legislation explicitly requires the state to recognise ‘the right of parents to ensure such education and teaching in conformity with their own religious and philosophical convictions’. That recognition, it is argued, protects two freedoms: the freedom of parents to choose schools and the freedom of ‘individuals and bodies’ to deliver education. There are two underlying concerns:
- at best, the state has imperfect knowledge of a certain child or family’s needs, let alone the capability to meet those needs;
- at worst (noting the origin of that legislation directly following the Second World War) authoritarian actors can use the state’s power to deliver bad outcomes to society, families and individuals.
The current Schools and Welfare Bill contains measures that will increase uniformity in the maintained sector. Similarly the Government’s SEND strategy is to reduce provision in the independent sector and to bring more taxpayer-funded SEND provision into state-operated mainstream schools or specialist settings. Both imply less choice for parents and also ‘individuals and bodies’ wishing to open and operate schools. Given the dearth of choice in the maintained sector, the choices available via the independent sector become more valuable.
As explained here, it is not correct to assume that choice is only available to the very wealthy. About a third of feepaying children come from households with earnings outside the top two deciles; a sixth from households below median. Such families exercise choice by minimising consumption, using schools at the lower end of the fee range, via bursaries, going the extra mile at work, and by using debt or forgoing savings in the expectation of a longer working life.
As supporters of independent education rightly insist, these choices are accessible to a wide range of incomes, as the below Venn diagram indicates. As I explained here, most of the families in the blue ‘can afford/can easily afford’ areas also exercise choice in the form of tutoring and catchment areas. As a ‘tax on the rich’, the education tax fails absolutely.
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Taxing education will shrink the independent education sector, according to the optimistic estimates provided by the Government, and in worse scenarios, we expect closures and consolidation, forcing smaller schools to form larger schools in search of efficiencies. Contraction, closure and consolidation all reduce the choices that society, and human rights legislation, value.
These observations are of no concern to families content with taxpayer-funded education, or a Government wishing to improve the maintained sector. They matter to families and ‘individuals and bodies’ seeking choices, and to society’s interest in the existence of these choices.
Competition
Governments fund competition regulators to ensure markets work in the interests of customers. Standard supply-side recommendations include reducing barriers-to-entry, encouraging comparison, encouraging choice and diversity and enabling search/switching by customers.
Competing providers that deliver quality, price and variety are rewarded; those that do not deliver, fail. Customers who shop around for value deliver benefit to themselves and also, by influencing price and quality, to other customers. Discerning customers’ demands shape the market: price-sensitive customers will drive different competitive outcomes compared to quality-seeking customers.
Internationally, it is normal to support competition in education:
- EU law provides for freedom from tax in education not only because it is a merit good providing social benefit, but also for state aid reasons: state entities should not be unfairly sheltered from competition;
- Several other countries including Denmark, Australia and Canada, and a growing number of US states, provide direct payment to independent schools, in order to support parental choice, and also in the interests of providing competition to the maintained sector.
- The UK taxpayer has generously subsidised networks of feepaying schools – as detailed in James Tooley’s book ‘The Beautiful Tree’ – via overseas aid, but not within our own borders. Good enough abroad, but not here?
Competition in education faces two sets of challenges. First, there are structural challenges, compared to, for example, markets for bread and other ‘fast-moving consumer goods’. Education features long-term relationships, very few switching points, high switching costs outside natural transitions and high barriers to entry for suppliers. Competition is local (to a lesser extent regarding boarding schools), which limits the field (families choose from a handful of local schools rather than from tens of thousands nationally).
Second, competition is challenged by the near-captive dominance and full taxpayer-subsidy provided to a 93% supplier (the Competition and Markets Authority defines a ‘working monopoly’ starting at 25% market share). Independent schools must distinguish themselves from what is provided ‘free’, typically by being different (meeting some particular need of children and families) or by being premium. Most middle and higher earners choose state schools, not necessarily because they are particularly good, but because they are ‘free’.
Given these two competition challenges, a responsible government (and a good economist) should be sensitive to the risk of making competition worse.
As the Adam Smith Institute Paper ‘Short Term Thinking‘ argues: ‘Applying VAT only to part of the private sector would distort competition.’ It is not clear why the Government has not considered the following effects:
- Taxing the only competitors to state-maintained schools makes it harder for independent schools to compete in exactly the ways that EU law was designed to protect (harming competition between independent schools and maintained schools);
- Contraction and consolidation of an already small independent sector makes it less internally competitive (harming competition between independent schools);
- The tax measures violate the principle of fiscal neutrality (see here for HMRC’s take: ‘Fiscal neutrality is a key feature of the VAT system. The VAT system must not distort competition between suppliers within the UK’); by discriminately taxing private provision for numerous services based on the delivery setting, for example music and drama lessons, out-of-hours wraparound and overnight care, tutoring and sporting activities (harming competition between independent schools and other private providers, and between independent schools and maintained schools that offer such services).
- The loss, from the independent sector, of the most financially-constrained and price-sensitive parents, leaves a greater proportion of parents who prefer quality and price-acceptance, reducing the likelihood that remaining schools compete on price.
These competition concerns point to further price increases and worse outcomes for families. The greater the displacement of children, contraction and consolidation of the sector, the worse the impact on competition.
This is the polar opposite of the supply-side reforms a competition regulator might recommend for a sub-sector of small providers trying to compete against a 93% state-backed incumbent.
Social Mobility
The Government’s fourth mission is to ‘Break Down Barriers to Opportunity’. It is not controversial to agree that improving education can improve opportunities. Unfortunately, a tax on education hinders social mobility in the following well-documented ways:
- Taxing education damages current and future prosperity and prosperity is a vehicle for social mobility:
– contraction of a sector that employs hundreds of thousands of people and generates significant exports;
– school closures, at worst in rural areas where the school is a linchpin of the local economy;
– loss of output via the labour supply risks identified by the Adam Smith Institute;
– reduced future prosperity due to reduced investment in social capital;
- A smaller, more expensive and more exclusive independent sector becomes harder to afford for lower and middle earners; the well-endowed world-famous schools with price tags to match are expected to thrive while provincial, affordable and niche providers are at greatest risk;
- Schools are likely to seek savings in their bursary and partnership programmes;
- Displacement of somewhat affluent families, with a strong preference for quality education, is likely to intensify competition for ‘preferred’ state schools, which tends to revolve around (VAT-free) tutoring or expensive houses in catchment areas, to the detriment of less well-off families. This effect may be exacerbated if local authorities use the arrangements outlined in the Schools Bill to limit the size of successful schools;
- The impact of reduced channels for social mobility within the independent sector will be disproportionately felt by children with particular needs who already face challenges of social mobility.
Conclusion
The economists responsible for the impact assessments of the education tax have failed to take account of ‘effects which must be foreseen’, with the effect of exacerbating the detestable ‘worst monopoly of all’. The effect is directly to undermine the Government’s missions #1, ‘Kickstart Growth’, and #4, ‘Break down barriers to opportunity’.
Where is today’s Bastiat?
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