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Trouble ahead at the Treasury

Unnoticed, the Lib Dems are driving through changes to the structure of personal tax allowances. And

For many politicians, tax cuts are the elixir of politics. In times of plenty they are deployed triumphantly as evidence of a thriving economy; in times of hardship they are handed down by chancellors as a salve to a hard-pressed public. So it should come as no surprise that, even in this parliament - dominated as it has been by arguments about fiscal austerity, tax rises and lower spending - there will be a growing debate about which taxes to cut.

Political gravity will ensure this is the case. As the economy gradually recovers - at the same time as the pain of the deepest and longest wage squeeze in living memory maintains its grip on family bank balances - politicians will be desperate to offer hope of better times ahead. They will know that tax cuts won't solve the structural problem of stagnant wages, nor will they deal with the rising pressures on the cost of living. And there will still be sharply differing views about whether tax cuts for some mean tax rises for others, as opposed to further cuts to spending. But have no doubt: all party leaders will be forced to offer respite to a public whose anger about falling living standards will reach boiling point over the next few years.

So, how will the coming tussle over tax cuts play out? There will be a few early skirmishes following the Budget, which inevitably included a few popular giveaways - such as the cut in fuel duty and support for first-time housebuyers - along with a tax cut for business (and let's not forget that George Osborne has already proved capable of pulling rabbits out of a hat, as with his dramatic promise to raise the inheritance-tax threshold in October 2007 - a move that skewered Labour's plans for an early general election).

Osborne clearly wants to burnish his credentials as a Lawson-like tax reformer as well as a spending cutter, so in the months ahead he'll talk up the radicalism of his long-term ambition to merge National Insurance and income tax. But the challenges involved in this are daunting, and the Conservatives are very unlikely to go into the next election having just raised the basic rate of income tax by 12p, so don't expect this to yield practical policies any time soon.

Indeed, it says something about the topsy-turvy state of today's politics that we need to look first at the Liberal Democrats to understand the shifting politics of tax. It is perhaps the least remarked-upon story in Westminster that the smaller and deeply unpopular coalition partner is driving one of the biggest changes in domestic policy - and in a department it doesn't even control. Not since the days of David Lloyd George have Liberal politicians had such influence over the Treasury's tax policies.

The ambitions of senior Lib Dems are not to be underestimated. Nick Clegg knows what he wants. He has been fighting hard for it internally and he is going to succeed in getting most of it - notably, a £10,000 income tax personal allowance at a total cost of more than £13bn (having already secured a commitment to a rise in the personal allowance from £6,475 to £7,475, increased in the Chancellor's 23 March Budget to £8,105 in April 2012.

Clegg's party has been emboldened by the quiescence of its Conservative partners. That is in part because the £10,000 commitment is a central fact of the coalition agreement, but it has also served the Conservative leadership's purpose to go along with something that deflects irritant calls from Boris Johnson and the Tory right to prioritise the removal of the 50p tax rate for the top 1 per cent of earners - a move that would delight Labour - just as it provides Tory leaders with a ready-made and voter-friendly tax-cutting agenda to talk about.

This context helps explain why senior Liberal Democrats, battered on so many fronts, are more ideologically self-confident than their coalition partners on this naturally Conservative terrain. They are the ones making the political weather on tax. Buoyed by this, they have set about working on what they should be seeking to achieve by 2015; and, more significantly, what their distinct Liberal ambitions for the tax system should be in 2020.

As part of their wider ideological journey, Clegg and those around him view themselves as the authors of a new "fiscal liberalism". This blends the spirit of John Stuart Mill's call for a generous, tax-free allowance sufficient for "life, health and immunity from bodily pain" with the modernising zeal of last year's Mirrlees Review (produced for the Institute for Fiscal Studies), which sets out far-reaching proposals for simplifying the UK tax system.

The priority is to achieve and then surpass the totemic commitment to increasing tax-free allowances. Don't be surprised when Liberal Democrat outriders call for a detailed plan for securing the £10,000 allowance in this parliament and £15,000 in the next.

The belief is that a "liberal tax system" should protect a greater chunk of individual earnings from the state, a sharp contrast with the social-democratic view that support for families, funded through progressive income taxes and tax credits, is the beating heart of a fair tax system. Nor do the Lib Dems' ambitions end here. Clegg is likely to push for further increases in green taxes - putting him on a direct collision course with Conservative backbenchers who want big cuts to fuel duty - and for raising more revenue from "unearned income".

Footloose families

One of the great political advantages of having a single, emblematic tax policy is that, in contrast to many of the tax changes of the Blair/Brown years, it is an easy thing to communicate. Quite simply, people are likely to get it. So where's the rub? The hard truth that Clegg and his team have largely sidestepped is that the simplicity of the allowance policy comes at a sig­nificant price: the distributional effects of the strategy are distinctly odd. Some high-income households (often with no children) gain quite a lot each time the allowance is raised, while many middle-income families with children gain nothing and, indeed, are set to lose a great deal (see chart 1), and the very poorest, who don't pay tax, won't get a penny.

This is not an accident: it is a direct result of tax cuts based on individual rather than household income. Further, because this year's increased tax allowance will be linked to a reduction in the income level at which the 40p tax rate kicks in, an extra 700,000 higher-rate taxpayers will be created in April.

For now, Clegg will shrug off these charges with the broad-brush argument that individual beneficiaries are overwhelmingly basic-rate taxpayers. He will not be so relaxed if a popular sentiment emerges that his prized tax strategy offers little to precisely those working (and politically footloose) middle-income families that hold the key to the next election.

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All of this gives the Labour leadership plenty to reflect on. Apart from airing its internal travails over the 50p rate, and Ed Balls's recent call for fuel to be exempt from the January VAT increase, Labour has said remarkably little about tax. Many on the political right, together with much of the media class - and some former New Labour figures - have already written off Miliband and Balls as big-state high taxers with no "feel" for the concern of people striving to get on in life, nor the discipline to rein in a party hard-wired to tax and spend. That is likely to be a serious misjudgement.

It was Balls and Miliband who came of age masterminding the commitment to stick to Tory spending plans, and showed the steel necessary to peg Labour to pre-1997 basic and top rates of tax. You don't go through that experience in your late twenties only to forget it in your early forties.

Recently Miliband has said that he supports "genuine" tax relief for low-to-middle-income earners but won't back a "tax con" in which a personal allowance giveaway is funded out of a hike in VAT. For now, that is a reasonable position: many low-to-middle-income earners will be worse off once increased allowances and VAT are taken into account; painfully so, once cuts to tax credits are factored in. But stick to this position for too long, and Labour will be badly exposed. Few expect the recent increase in VAT to be reversed come the next election. As chart 2 shows (below), the VAT rate has long been converging on the basic rate of income tax - Labour in power tends not to cut Conservative increases to VAT, whatever it says in opposition. Nor is there much prospect of it reversing the coalition's increased tax allowances and, in doing so, dragging many modest earners back into the tax system.

So, the risk is that Miliband ends up entering an election in 2015 saying little more than: "I now realise that I agree with Nick." Labour strategists with the ear of the leader are well aware of this conundrum and are starting to work out how to respond.

Their belief is that the coalition has made a big mistake in focusing so much of the pain of cuts on working families with children, and above all women. But they are also acutely aware that to make targeted tax cuts, at the same time as they rebuild their reputation for fiscal credibility, will be no mean feat.

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Miliband's team is heartened by private polling that it has seen on how the Obama 2008 campaign managed to break out of the Republican tax trap. With targeted tax cuts for the middle classes, the Democrats were able to change the framing question from whether each party was "for or against tax cuts" (the Democrats typically being "against") to "who do you want tax cuts for?". That freed Barack Obama to outpoll John McCain as a tax cutter for "middle-class America" at the same time as he won widespread support for tax rises for the richest 2 per cent. Labour thinks there are lessons to be learned.

Return of the 10p rate

So what are the likely directions for the different parties? No one should mistake the Conservatives' current focus on measures to boost growth with what is likely to become their agenda as we get closer to 2015. It is almost inconceivable that Osborne won't build up a formidable war chest over the next few years to fund a major commitment to cut the tax burden on families, as well as abolish the 50p rate, should the Tories win the election.

The Lib Dems have the immediate political task of reaping some popular reward for this April's increased tax allowances, and a deeper challenge - perhaps an insurmountable one - in making their strategy more appealing to middle-income families with children. One option would be to attempt to persuade the Treasury to build a child allowance into the tax system for basic-rate payers. But, apart from difficult questions about the administrative feasibility, this would ignite a huge row with the Tories, who still want to introduce a married couple's allowance. Even more significantly, senior Lib Dem strategists whisper that, in the longer term, they may need to open up a debate about moving from independent taxation to a system based on household income - as was the case before 1988. The implications of this should not go unmissed: any public contemplation of ditching one of the proudest achievements of modern feminism in the name of liberal tax reform would be explosive.

And Labour? It will try to home in on the electoral sweet spot - modest- and middle-income families with children, on a household income of between roughly £25,000 and £50,000. Less clear is what it wants to offer this group. There is already scepticism in senior circles about whether it would be enough merely to reverse some of the coalition's cuts to tax credits; a fundamental rethink is needed. This would involve looking at benefits as well as taxes and grappling with thorny problems such as child benefit - something not lost on Labour strategists, who are quick to point out that "we never said all aspects of universalism are sacrosanct".

The idea would be to create a simpler way for the tax and benefit system to support modest-income families that are going to lose from cuts to tax credits, as well as middle-income families that are going to be hit by the axing of their child benefit. At the same time, Labour will have to act to support the very lowest-paid. An intriguing option here, which would also help make peace with Labour's recent past, would be to consider a reduced tax rate for the lowest earners: might we see the return of the 10p rate?

The cost of cuts

Above all, Labour will have to balance intense and contradictory pressures for tax cuts, targeted increases in spending and the rebuilding of its fiscal credibility. Harder still, any new tax cuts will be expensive. Given the size of low-to-middle-income Britain, a few billion pounds won't stretch far; a meaningful cut is likely to cost over £10bn. In view of the fiscal outlook, Labour strategists realise that they will have to raise taxes for some in order to cut for others - as do those Lib Dems who accept that, by the next election, public spending will need to recover with growth rather than be cut further.

When it comes to income tax, there is very little room for manoeuvre. The 40p rate already kicks in at a relatively low and falling level, and there is no support for raising the 50p rate. A further increase in VAT is out of the question. This suggests the need for new ways of raising revenue from wealth and high-value housing. Expect to hear squeals in response to a Labour version of a "mansion tax", a continued push on bankers' bonuses, further savings on pension-tax relief for the highest earners and new ideas for raising money from capital gains and inheritance. Generating income from these sources will be a stiff test of Labour's resolve: the party will face bitter opposition.

In the years ahead, however, the crisis of living standards will lead to something rather like a primal scream from low-to-middle-income households, demanding relief as they become even more resentful of growing wealth at the top. The politics of taxing affluence in 2015 won't be the same as they were in 2010, never mind 1997: on this matter, the past doesn't provide a guide to the future. As Obama showed in 2008, it is possible to forge a common set of interests between low- and middle-income earners and a narrative on tax that speaks to the extraordinary times in which we are living.

Gavin Kelly is chief executive of the Resolution Foundation

Gavin Kelly is a former adviser to Downing Street and the Treasury. He tweets @GavinJKelly1.

This article first appeared in the 28 March 2011 issue of the New Statesman, Why Libya? Why now?

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Are smart toys spying on children?

If you thought stepping on a Lego was bad, consider the new ways in which toys can hurt and harm families.

In January 1999, the president of Tiger Electronics, Roger Shiffman, was forced to issue a statement clearing the name of the company’s hottest new toy. “Furby is not a spy,” he announced to the waiting world.

Shiffman was speaking out after America’s National Security Agency (NSA) banned the toy from its premises. The ban was its response to a playground rumour that Furbies could be taught to speak, and therefore could record and repeat human speech. “The NSA did not do their homework,” said Shiffman at the time.

But if America’s security agencies are still in the habit of banning toys that can record, spy, and store private information, then the list of contraband items must be getting exceptionally long. Nearly 18 years after TE were forced to deny Furby’s secret agent credentials, EU and US consumer watchdogs are filing complaints about a number of WiFi and Bluetooth connected interactive toys, also known as smart toys, which have hit the shelves. Equipped with microphones and an internet connection, many have the power to invade both children’s and adults’ private lives.

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“We wanted a smart toy that could learn and grow with a child,” says JP Benini, the co-founder of the CogniToys “Dino”, an interactive WiFi-enabled plastic dinosaur that can hold conversations with children and answer their questions. Benini and his team won the 2014 Watson Mobile Developer Challenge, allowing them to use the question-answering software IBM Watson to develop the Dino. As such, unlike the “interactive” toys of the Nineties and Noughties, Dino doesn’t simply reiterate a host of pre-recorded stock phrases, but has real, organic conversations. “We grew it from something that was like a Siri for kids to something that was more conversational in nature.”

In order for this to work, Dino has a speaker in one nostril and a microphone in the other, and once a child presses the button on his belly, everything they say is processed by the internet-connected toy. The audio files are turned into statistical data and transcripts, which are then anonymised and encrypted. Most of this data is, in Benini’s words, “tossed out”, but his company, Elemental Path, which owns CogniToys, do store statistical data about a child, which they call “Play Data”. “We keep pieces from the interaction, not the full interaction itself,” he tells me.

“Play Data” are things like a child’s favourite colour or sport, which are used to make a profile of the child. This data is then available for the company to view, use, and pass on to third parties, and for parents to see on a “Parental Panel”. For example, if a child tells Dino their favourite colour is “red”, their mother or father will be able to see this on their app, and Elemental Path will be able to use this information to, Benini says, “make a better toy”.

Currently, the company has no plans to use the data with any external marketers, though it is becoming more and more common for smart toys to store and sell data about how they are played with. “This isn’t meant to be just another monitoring device that's using the information that it gathers to sell it back to its user,” says Benini.

Sometimes, however, Elemental Path does save, store, and use the raw audio files of what a child has said to the toy. “If the Dino is asked a question that it doesn’t know, we take that question and separate it from the actual child that’s asking it and it goes into this giant bucket of unresolved questions and we can analyse that over time,” says Benini. It is worth noting, however, that Amazon reviews of the toy claim it is frequently unable to answer questions, meaning there is potentially an abundance of audio saved, rather than it being an occasional occurrence.

CogniToys have a relatively transparent Privacy Policy on their website, and it is clear that Benini has considered privacy at length. He admits that the company has been back and forth about how much data to store, originally offering parents the opportunity to see full transcripts of what their child had been saying, until many fed back that they found this “creepy”. Dino is not the first smart toy to be criticised in this way.

Hello Barbie is the world’s first interactive Barbie doll, and when it was released by Mattel in 2015, it was met with scorn by parents’ rights groups and privacy campaigners. Like Dino, the doll holds conversations with children and stores data about them which it passes back to the parents, and articles expressing concerns about the toy featured on CNN, the Guardian, and the New York Times. Despite Dino’s similarities, however, Benini’s toy received almost no negative attention, while Hello Barbie won the Campaign for a Commercial-Free Childhood’s prize for worst toy of the year 2015.

“We were lucky with that one,” he says, “Like the whole story of the early bird gets the worm but the second worm doesn’t get eaten. Coming second on all of this allowed us to be prepared to address the privacy concerns in greater depth.”

Nonetheless, Dino is in many ways essentially the same as Hello Barbie. Both toys allow companies and parents to spy on children’s private playtimes, and while the former might seem more troubling, the latter is not without its problems. A feature on the Parental Panel of the Dino also allows parents to see the exact wording of questions children have asked about certain difficult topics, such as sex or bullying. In many ways, this is the modern equivalent of a parent reading their child's diary. 

“Giving parents the opportunity to side-step their basic responsibility of talking to, engaging with, encouraging and reassuring their child is a terrifying glimpse into a society where plastic dinosaurs rule and humans are little more than machines providing the babies for the reptile robots to nurture,” says Renate Samson, the chief executive of privacy campaign group Big Brother Watch. “We are used to technology providing convenience in our lives to the detriment of our privacy, but allowing your child to be taught, consoled and even told to meditate by a WiFi connected talking dinosaur really is a step in the wrong direction.”

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Toy companies and parents are one thing, however, and to many it might seem trivial for a child’s privacy to be comprised in this way. Yet many smart toys are also vulnerable to hackers, meaning security and privacy are under threat in a much more direct way. Ken Munro, of Pen Test Partners, is an ethical hacker who exposed security flaws in the interactive smart toy “My Friend Cayla” by making her say, among other things, “Calm down or I will kick the shit out of you.”

“We just thought ‘Wow’, the opportunity to get a talking doll to swear was too good,” he says. “It was the kid in me. But there were deeper concerns.”

Munro explains that any device could connect to the doll over Bluetooth, provided it was in range, as the set-up didn’t require a pin or password. He also found issues with the encryption processes used by the company. “You can say anything to a child through the doll because there's no security,” he says. “That means you've got a device that can potentially be used to groom a child and that's really creepy.”

Pen Test Partners tells companies about the flaws they find with their products in a process they call “responsible disclosure”. Most of the time, companies are grateful for the information, and work through ways to fix the problem. Munro feels that Vivid Toy Group, the company behind Cayla, did a “poor job” at fixing the issue. “All they did was put one more step in the process of getting it to swear for us.”

It is one thing for a hacker to speak to a child through a toy and another for them to hear them. Early this year, a hack on baby monitors ignited such concerns. But any toy with speech recognition that is connected to the internet is also vulnerable to being hacked. The data that is stored about how children play with smart toys is also under threat, as Fisher Price found out this year when a security company managed to obtain the names, ages, birthdays, and genders of children who had played with its smart toys. In 2015, VTech also admitted that five million of its customers had their data breached in a hack.

“The idea that your child shares their playtime with a device which could potentially be hacked, leaving your child’s inane or maybe intimate and revealing questions exposed is profoundly worrying,” says Samson. Today, the US Electronic Privacy Information Center (EPIC) said in a statement that smart toys “pose an imminent and immediate threat to the safety and security of children in the United States”. 

Munro says big brands are usually great at tackling these issues, but warns about smaller, cheaper brands who have less to lose than companies like Disney or Fisher Price. “I’m not saying they get it right but if someone does find a problem they’ve got a huge incentive to get it right subsequently,” he says of larger companies. Thankfully, Munro says that he found Dino to be secure. “I would be happy for my kids to play with it,” he says. “We did find a couple of bugs but we had a chat with them and they’re a good bunch. They aren’t perfect but I think they’ve done a hell of a lot of a better job than some other smart toy vendors.”

Benini appears alert to security and the credibility it gives his company. “We took the security very, very seriously,” he says. “We were still building our systems whilst these horror stories were coming about so I already set pipelines and parameters in place. With a lot of devices out there it seems that security takes a backseat to the idea, which is really unfortunate when you’re inviting these devices into your home.”

As well as being wary of smaller brands, Munro advises that parents should look out for Bluetooth toys without a secure pairing process (ie. any device can pair with the toy if near enough), and to think twice about which toys you connect to your WiFi. He also advises to use unique passwords for toys and their corresponding apps.

“You might think ‘It's just a toy, so I can use the same password I put in everything else’ – dog’s name, football club, whatever – but actually if that ever got hacked you’d end up getting all your accounts that use that same password hacked,” he says.

Despite his security advice, Munro describes himself as “on the fence” about internet-connected smart toys as a whole. “Most internet of things devices can be hacked in one way or another,” he says. “I would urge caution.”

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Is all of this legal? Companies might not be doing enough ethically to protect the privacy of children, but are they acting responsibly within the confines of the law?

Benini explains that Dino complies with the United States Children's Online Privacy Protection Act (COPPA) of which there is no real equivalent in the UK. COPPA says that companies must have parental permission to collect personal information over the internet about children under 13 years of age. “We’ve tried to go above and beyond the original layout of COPPA,” says Benini, when describing CogniToys transparent privacy documents. Parents give their consent for Elemental Path to collect their children’s data when they download the app that pairs with the toy.

Dino bears a striking similarity to Amazon Echo and Google Home, smart speakers that listen out for commands and questions in your home. Everything that is said to Amazon Echo is recorded and sent to the cloud, and an investigation by the Guardian earlier this year discovered that this does not comply with COPPA. We are therefore now in a strange position whereby many internet of things home devices are legally considered a threat to a child’s privacy, whereas toys with the same capabilities are not. This is an issue because many parents may not actually be aware that they are handing over their children’s data when installing a new toy.

As of today, EU consumer rights groups are also launching complaints against certain smart toys, claiming they breach the EU Unfair Contract Terms Directive and the EU Data Protection Directive, as well as potentially the Toy Safety Directive. Though smart toys may be better regulated in Europe, there are no signs that the problem is being tackled in the UK. 

At a time when the UK government are implementing unprecedented measures to survey its citizens on the internet and Jeremy Hunt wants companies to scour teens’ phones for sexts, it seems unlikely that any legislation will be enacted that protects children’s privacy from being violated by toy companies. Indeed, many internet of things companies – including Elemental Path – admit they will hand over your data to government and law enforcement officials when asked.

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As smart toys develop, the threat they pose to children only becomes greater. The inclusion of sensors and cameras means even more data can be collected about children, and their privacy can and will be compromised in worrying ways.

Companies, hackers, and even parents are denying children their individual right to privacy and private play. “Children need to feel that they can play in their own place,” says Samson. It is worrying to set a precedent where children get used to surveillance early on. All of this is to say nothing of the educational problems of owning a toy that will tell you (rather than teach you) how to spell “space” and figure out “5+8”.

In a 1999 episode of The Simpsons, “Grift of the Magi”, a toy company takes over Springfield Elementary and spies on children in order to create the perfect toy, Funzo. It is designed to destroy all other toys, just in time for Christmas. Many at the time criticised the plot for being absurd. Like the show's prediction of President Trump, however, it seems that we are living in a world where satire slowly becomes reality.

Amelia Tait is a technology and digital culture writer at the New Statesman.