The Political Economy of Choice: why voting matters

by George Hatjoullis

Elections are looming in the UK and the apathetic outnumber the enthusiastic. Why should I vote, is the refrain, the government always get in. Voters see little difference between the parties except at the extremes of the spectrum, and these parties carry a lot of baggage that most voters do not want to adopt. The sensible political middle is a blur and voters cannot distinguish between the antagonists. The result always seems to be the same. There is, however, an important policy difference that seems to go unnoticed; choice.

Choice is valued in economics. The logic is this; if I you offer the opportunity to do whatever you were going to do and a chance to do something else, then you are better off. After all, you can still do what you were going to do. How can choice be bad? The problem is that choice comes with responsibility. If you are given more choice then you must live with the consequences of your choice, and not expect to be bailed out (by the state) if you make a bad choice. Otherwise moral hazard kicks in. If poor choices are underwritten (by the state) then individuals will have no incentive to make wise choices. Moreover, they may make inappropriate decisions that have nice outcomes, if they work, but that are unlikely to be successful. The (state) bail out then kicks in unless moral hazard is recognised. Different attitudes to choice and moral hazard are evident along the political spectrum.

The attitude to choice and moral hazard is an important distinguishing feature along the political spectrum. Broadly speaking, the ‘right’ favours individual choice and no moral hazard. The ‘left’ favours less individual choice and is happy to accept some moral hazard. The ‘left’ recognise that individuals make bad choices and want the state to underwrite bad outcomes for individuals. The ‘left’ recognise that in underwriting individual choice outcomes they create moral hazard, so they seek to minimise the moral hazard by limiting the choice. The ‘right’ offer the choice without the safety net. This is why we hear so much about the ‘nanny state’, ‘benefit scroungers’ and ‘tax dodgers’.

This is, of course, oversimplified because outcomes are not simply choice determined. There is bad luck and inheritance to consider (both physical and social inheritance). The fact that luck and inheritance are not equally distributed biases the ‘left’ to less choice and more safety net. The fact that inheritance is not equally distributed most likely biases the ‘right’ to more choice and less of a safety net, and thus less moral hazard.

Voting does matter. If you choose not to vote the government will still get in. It works both ways. Moreover, the government will have a distinct bias on the issues of choice, personal responsibility and moral hazard. By choosing not to vote you will have made a passive choice on one side of this important issue. Why not choose the side you prefer by voting.

An interesting example of the choice aspect of policy is in the Pension Flexibility Reforms.The main change is that retirees with defined contribution pension arrangements can take their pensions as they see fit. Defined contribution pensions are those that provide a lump sum from which an income can be generated. The same freedom has been extended to some types of defined benefit schemes. Defined benefit pensions promise you a defined income at retirement. It is still possible to take 25% of the pot as a tax-free lump sum. However any other income taken will be taxable at your marginal tax rate so be careful. If you take the whole amount in one year you may end up paying 45% tax on all or some of the remaining amount withdrawn.

Another important change is that retirees can now pass on unused pension pots free of tax, including, it seems, inheritance tax. A pension holder that dies before age 75 can pass on the residual pension assets to anyone as a lump sum, free of tax. After age 75, the same applies but the person receiving the inheritance must pay tax at 45% on a lump sum or their relevant marginal income tax rate if they take the inheritance as income.

The government has responded to criticism that this greater flexibility may lead to poor choices by making free guidance available through the Pensions Advisory Service and the Citizens Advice Bureau. However, guidance is not advice. Ideally, everyone should take some advice before making any irrevocable pension decisions but advice is expensive and may be uneconomic for those with small pension pots. Indeed, it may be difficult to find advice for small pension pots. The fear that these reforms are unwise because they may lead to poor decisions by some people, and may result in these people becoming a burden on the state, is probably exaggerated.The main concern that has been expressed is that retirees will drawdown their pension pots too quickly. If they do then they will incur higher than necessary tax charges. This seems an odd concern. The state receives more tax now and thus has been largely reimbursed for any future help it may need to provide for the impecunious retiree that has spent the pot too quickly. The moral hazard is thus partly funded.

Pension problems are not new and have little to do with these reforms. Retirees may not have saved enough. This is the source of the so-called ‘Pension Crisis’. Increased life expectancy and low bond yields mean that pension pots no longer provide for an adequate secure income. Financial services providers may charge too much and erode the funds. The new flexibility has in fact awoken the industry and some charges have started to come down. The Financial Conduct Authority is also taking the matter of charges quite seriously. Poor investment decisions may erode the funds. This has also been a problem in accumulating funds. All of these problems were evident under previous arrangements. The additional flexibility has not made the problems worse. It has merely given the retiree more degrees of freedom. She or he need not use it. They can always do as they would have without the freedom.