Wednesday, May 23, 2018

We'll get a very clear choice at the election

The federal election campaign could be as soon as August and no later than May. So which side is shaping as better at managing the economy?

Sorry, I won’t be answering that question. If you’re smart enough to choose to read this august organ, you’re smart enough to make up your own mind – which you probably already have.

The partisan or tribal approach to politics – if my side’s proposing it, it’s what I prefer – is a common way of economising on thinking time.

But I’m paid to scrutinise the propositions coming from both sides, so let me offer some pointers to help those who do want a better understanding of the choice available.

The first point is one that will be forgotten from the moment the election’s called: the main instrument used to manage the economy through the ups and downs of the business cycle is interest rates (“monetary policy”).

So the day-to-day management of the economy is done not by the politicians in Canberra, but by the econocrats at the Reserve Bank in Sydney. Neither side has shown the least indication of wanting to change this.

It means that, apart from making decisions affecting the activities of particular industries (the banks, the live meat export trade) or such minor concerns as the natural environment, the elected government’s main means of influencing the broader economy is via its budget: the taxes it raises, the things it chooses to spend on, and the gap – the deficit or surplus – it leaves between the two (“fiscal policy”).

It’s now clear the election campaign will focus on taxes and government spending. Rather than sticking to the usual approach of making itself a small target against an unpopular government by saying “me too” to most of the government’s policies, Labor is making itself a big target, with various policies the Coalition has opposed.

So in this campaign we’ll be given a wider choice than usual, with each side conforming more than usually to their left versus right stereotypes. Labor will be promising to spend more on health and education than the Coalition, offering bigger tax cuts than the Coalition (in the first few years, anyway), and promising to reduce deficit and debt faster than the Coalition.

Against this, Malcolm Turnbull has used the big tax cuts announced in the budget to position the Coalition as the low spending, low taxing side, compared to Labor’s big spending, big taxing alternative.

This glosses over the Coalition’s own record on tax and spending, but there is some truth to the characterisation.

Remember, however, that neither side is promising anything but a temporary fix to bracket creep, because neither side is confident of its ability to contain the growth in government spending. So it’s probably closer to the truth to say that, however much Labor taxes and spends, the Coalition will do a bit less.

But how on earth can Labor promise to spend more, tax less and improve the budget balance faster?

Thankfully, we won’t be hearing much of the “Where’s the money coming from?” cry because Labor has a not-so-secret weapon: it has already announced policies to increase tax collections by reducing negative gearing and the capital gains tax discount, further reducing superannuation tax
concessions, taxing family trusts, ending cash refunds of unused franking credits, raising the top income tax rate by 2 percentage points to 49 per cent, and abandoning the cut in the rate of company tax for big businesses.

These measures should increase taxes by about $30 billion over four years and almost $200 billion over 10 years. They’ve been costed by the Parliamentary Budget Office, so there’s also likely to be less campaign argy-bargy over the costing of promises.

Labor has matched the government’s $530-a-year tax cut for middle and above-middle income-earners and raised it to $928. But it’s still considering whether to match the second step of lifting the 32.5 per cent tax upper bracket limit from $90,000 a year to $120,000 in July 2022. It’s unlikely to match the third step of lifting that limit to $200,000 in July 2024.

This tells us that neither side is particularly generous to genuinely low income-earners, and both have an exaggerated impression of where the middle is.

The big difference between the sides emerges for people earning more than $90,000 a year (which is almost 60 per cent higher than the median income), to whom the Coalition is offering much bigger tax cuts – while Labor would actually raise the tax rate on incomes above $180,000, as well as aiming most of its reductions in tax breaks at high income-earners.

So Labor would make income tax more redistributive, whereas the Coalition would make it less so. If that doesn’t offer voters a real choice, I don’t know what would.

But all is not as clear-cut as it sounds. For a start, both sides are engaged in a tax-cut bidding war while the budget is still in deficit with a rising debt. Both sides are relying on the government’s quite optimistic forecasts and projections in the budget. What if they don’t come to pass?

Also, what politicians promise and what they can get passed by Parliament are two different things. As Phillip Coorey of the Financial Review has revealed, the likely composition of the Senate after the election – fewer, but more conservative cross-benchers - should make it easier for the Coalition than for Labor to get its policies into law.
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Monday, May 21, 2018

Let's outlaw she'll-be-right budget projections

The practice of including in the budget 10-year “medium-term” projections of the budget balance and net debt is pernicious. It should be abandoned in the interests of responsible economic management.

It’s supposed to increase transparency and accountability, but in practice does more harm than good, presenting the government of the day with an almost irresistible temptation to portray the future as more assured than it is.

The future is unknowable. We can’t forecast the economy even a year ahead with any accuracy, but what we can be most sure of is that, even with pure motivations, a mechanical projection out 10 years is highly likely to be way off-beam.

We know the economy never moves in straight lines, but each year’s 10-year projection shows it on glide path to where we want to be. Obviously, no account is taken of unexpected shocks to the economy – even though it’s a safe bet there’ll be more than a few in the space of a decade.

Treasurers' unworthy intention is to leave non-economists with the impression everything’s under control and on the improve. But I think it’s likely to leave even our economists and econocrats with a false sense of comfort. If you doubt that, you haven’t read Daniel Kahneman’s Thinking Fast and Slow.

I remember how proud the Hawke government’s hard-man finance minister, Peter Walsh, was after persuading the cabinet to include in the budget papers not just the figures for the budget year, but also for the following three years of “forward estimates”.

This would improve transparency and accountability, making it harder for governments to hide the budgetary consequences of their decisions in later years.

But when Labor’s Wayne Swan came under pressure to get the budget deficit down in the early years of this decade – struggling with the big-spending proclivities of his successive prime ministers – he soon realised the way to make the deficit look like it was headed steadily in the right direction was to “re-profile” big spending commitments into more convenient years.

In particular, he was always using his “fiscal bulldozer” to push spending commitments beyond the three-year forward estimates, where they couldn’t be seen.

As commentators started drawing attention to this trick it became clear he’d have to bolster the budget’s credibility by providing some sort of answer to the question of what would happen beyond the forward estimates.

Thus the greater weight put on medium-term projections. Thus has the budget’s purview been inflated from one year to 10 – all with without succeeding in curbing treasurers’ temptation to mislead. From wherever he’s watching on, I doubt the late hard-man of Finance is cheering.

Sad to say, the medium-term projection has been about deception – both numerical and visual – from the off. In all the budgets since Swan introduced them, never once has the budget balance failed to glide smoothly up to a healthy surplus, nor the net debt failed to glide smoothly down towards zero.

How’s it done? By making assumptions, of course. Assumptions are the unavoidable basis for all “projections”. But the proof that the budget’s projections have always been more for support than illumination is that never have the assumptions been fully and clearly spelt out.

In this budget, what little explanation there is has been sprinkled through three different chapters (“statements”) of budget paper No.1. Buried in statement three is the warning that “projections of the receipts impact over the medium term are subject to higher levels of uncertainty and are sensitive to changes in economic conditions, underlying assumptions and forecasts”.

And this year Treasury seems to have slipped into statement two the additional warning that assuming the spare capacity in the economy is absorbed over five years from the first year of the projections is “a well-established approach but it is not without drawbacks”.

The key assumptions are: the rate at which government spending will grow – which will be based on any new (financial) year’s resolution the government has made to be frugal in future – and the economy’s medium-term “potential” rate of growth, when we’ll get back to it and how quickly we’ll use up the (estimated) spare capacity once we have.

This year’s fine print acknowledges that the assumed potential growth rate of 2.75 per cent a year is based partly on the assumption that labour productivity grows each year at its 30-year average rate of 1.6 per cent. But former top econocrat Dr Mike Keating notes that the average over the past decade is only 1.35 per cent – which makes a big difference.

Even without the ever-present temptation to fudge, projections are a device for deluding ourselves we know more about the future than we do. By ignoring all the uncertainties, they breed not understanding, but complacency. An honest government would abandon the practice.
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Saturday, May 19, 2018

Morrison's tax cuts aim well above the middle

One thing to be said in favour of Scott Morrison’s complex three-step, seven-year tax plan is that his small tax cuts for the deserving middle income-earners are more likely to actually happen than the huge tax cuts for the undeserving high income-earners.

For the latter to eventuate, Malcolm Turnbull will have to be re-elected at least twice before July 2024. By contrast, the smaller cuts will start in six weeks’ time. For once it’s the rich who’re being promised pie in the sky (hopefully) before they die.

This means it’s wrong to simply compare the $530-a-year saving for people on middle incomes with the $7225-a-year saving for all of us struggling to get by on more than $200,000 a year.

Why? Because by the time the people on such big incomes are due to get their tax cut, the others will already have had their much smaller cuts every year for six years.

The thing about money is that the sooner you get your hands on it, the better. Economists call this “the time-value of money”.

But that about exhausts the good points of ScoMo’s tax plan. His claim that it would make income tax “lower, simpler and fairer” is debatable.

Even his claim that the first step in his cuts is aimed a “low and middle income-earners” is misleading. People accept such claims only because they have no idea where the middle is.

ScoMo wants to overstate the level at which the middle is situated because his tax cuts are designed to favour the better-off.

He quotes the average weekly earnings of full-time employees – about $85,000 a year – as his indicator of the middle. But way more than half of full-time workers earn less than this.

That’s because the super-high salaries of a relative handful of employees push up the arithmetic average (the mean), making it a misleading measure of “central tendency”.

No, the better measure is the median – the income that’s higher than half the other incomes and lower than half the others. That is, the one dead in the middle. A high proportion of all full-timers will be clustered in roughly equal proportions a bit above and below the median.

The median income of adult full-time employees is about $76,000 – almost 11 per cent lower than the mean. But this measure ignores almost a third of workers who are part-time. Don’t they pay tax?

The median income of all employees is about $57,000 – which is a much better indicator of “the middle of the middle”.

ScoMo’s full tax saving of $530 a year (about $10 a week) will go to the 4.4 million taxpayers earning between $48,000 and $90,000 a year. That range goes from 16 per cent below the all-employees median to 58 per cent above it. Touch of asymmetry there. But there’s more.

On the upside, the 1.5 million taxpayers earning between $90,000 and $125,000 get a saving that starts at $530 and slowly reduces until it reaches zero at the top of this bracket.

On the downside, the 1.8 million taxpayers earning between $37,000 and $48,000 a year get a saving of $530 at the top, which then falls to $200 at the bottom of the bracket, while the 2.4 million taxpayers earning between $18,000-odd and $37,000 get nothing at the bottom, rising to $200 at the top.

Now, what would be a good indicator of a low income? Well, the minimum full-time wage is about $36,000 - meaning these people get a saving of about $185 a year or $3.60 a week. Wow. That much?

And what about all the under-employed workers who can’t get as many hours as they need. Aren’t they low income-earners? Their saving could be as little as zilch.

Still think ScoMo’s first step is aimed at “low and middle income-earners”? The truth is it’s aimed at middle and upper-middle earners. Anyone well below the middle gets peanuts.

Morrison’s claim that his plan would make income tax simpler is based on his second and third steps, in July 2022 and July 2024, finally eliminating the 37¢-in-the-dollar bracket, reducing the rate scale from five brackets to four.

But his changes would make the system more complex by introducing a new “low and middle-income tax offset”, to go on top of the existing low-income tax offset.

The effect of both offsets could have been incorporated into the rate scale, but hasn’t been. Why not? Because leaving them separate stops people seeing the extra tax rate (1½¢ in the dollar) they pay as their eligibility for the tax offset is clawed back to zero.

The Australian Taxpayers Alliance has demonstrated that, far from reducing the tax scale from five brackets to four, in truth the plan increases them from eight to 10. That’s simpler?

Our income tax is “progressive” because successive slices of your income are taxed at progressively higher rates. It would stay progressive under ScoMo’s plan, because it would still go from a first bracket where the tax rate is zero, to a top bracket where the rate is 45¢ in the dollar.

But it would, in a sense, be less progressive in that, after step three, almost three-quarters of taxpayers would end up in a huge bracket running from $41,000 to $200,000, all with a “marginal” tax rate of 32.5¢ on the last part of their income.

A better way to put it, however, is that ScoMo wants to put a big kink in the progressive scale. As your income rose above $200,000, your marginal tax rate would suddenly leap from 32.5¢ to 45¢.

Why is every country’s income tax scale progressive? Because making people contribute a higher proportion of their income according to their “ability to pay” is considered fairer.

When Morrison claims his changes would make the system fairer, he’s turning the meaning of the word on its head. He thinks the system would be fairer if high income-earners had to pay a smaller proportion of their incomes in tax.
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Tuesday, May 15, 2018

Morrison's peculiar tax cuts designed to hide the truth

As a boy I was interested in magic tricks, reading lots of books and learning to do a few. It taught me two terms that have proved invaluable to me as an economic journalist: “prestidigitation” and “sleight of hand”.

The trick is to draw the audience’s attention towards something else so they don’t notice you palming the coin or grabbing the rabbit you’ll supposedly produce from your top hat.

Politicians and their spin doctors are always trying to divert our attention from some embarrassing stuff-up, but it’s come to something when a treasurer produces a budget as tricksy as Scott Morrison’s effort last week.

His description of his three-step, seven-year tax cut, why it’s needed, and what it would achieve, were all calculated to mislead. Each part of his claim that it would bring about “lower, fairer and simpler” taxes is open to dispute.

The peculiar design of his cuts gives prominence to his immediate but modest cuts for “low and middle income earners”, while playing down the much more valuable cuts going later to the well-off (including a certain economic journo – in year seven I’m looking at a saving of $7225 a year).

If you’re out to bamboozle, it’s easy to do it with numbers. Income tax is complicated because it involves your income being taxed in slices, with the rate of tax on each slice getting progressively (note that word) higher.

At present, the tax rates start at zero for the first $18,000-odd of annual income, then 19 per cent for the next $19,000-odd, then 32.5 per cent for the next $50,000, 37 per cent for the next $93,000 and 45 per cent for everything over that total of $180,000.

Many people imagine the rate they pay on the last slice of their income (their “marginal” tax rate) is the rate they pay on all of it but, clearly, their overall average rate of tax will be much lower.

People on more than $200,000 would see no reduction in their marginal tax rate of 45 per cent. Their eventual saving of a flat $7225 a year comes from all the increases in the size of the slices that are taxed at lower rates than their marginal rate.

Morrison claims his plan is fair because lower income-earners would enjoy the biggest percentage reductions in their tax bill. People earning $30,000 a year would get an 8.3 per cent reduction in their tax over the seven years, he says, compared with a 2.5 per cent reduction for those on $200,000.

This is true, but it’s just playing with percentages. You’d hope the Treasurer was sufficiently numerate to understand that even a small reduction in a small amount will be a higher percentage than a much bigger reduction in a really big amount.

There was a time when the cover price of this august organ was raised from one penny to two. You could call that a 100 per cent increase but, even in those days, a penny wasn’t a lot of money.

What matters when comparing your tax cut with mine is not the percentage reduction in the tax we each pay, but the amount of each person’s tax saving compared with the amount of their income. As a tax economist would put it, what matters is the percentage-point change in someone's overall average rate of tax.

Turns out the average tax rate of someone on $30,000 would fall from 8 per cent to 7.3 per cent. They’d save an average of 0.7¢ for each dollar of income.

Someone on $200,000 would see their average tax rate fall from 33.6 per cent to 30 per cent, a saving of 3.6¢ for each dollar of income.

On incomes up to $100,000, the saving varies around 1¢ in the dollar, then rises steeply up to the peak of 3.6¢ at $200,000. That’s fair?

But Morrison is happy to justify the much better deal he wants to give very high income-earners. He repeats a favourite complaint of the rich, that the 3 or 4 per cent of all taxpayers on the top marginal tax rate pay 30 per cent of all the income tax raised.

This is classic fiscal sleight of hand. For a start, it ignores that the tiny band of tax martyrs also earn a huge share of the total income. More than 18 per cent. But that’s just their taxable income, after they’ve done all they can to minimise it.

The economist Saul Eslake reminds us that the martyrs account for more than 22 per cent of all taxpayers claiming net rental losses on negatively geared properties, and for more than 13 per cent of total losses. They account for 64 per cent of the annual value of realised capital gains, only half of which is taxable.

Another part of the illusion is that the rich whingers want us to forget that personal income tax is just the biggest and most visible of our taxes. It accounts for only half of all the federal tax we pay, and when you add in state taxes its share falls to 40 per cent.

Most of those other taxes, particularly the GST and sin taxes, are “regressive” – the poor lose a higher proportion of their income than the rich. Take account of the other 60 per cent of tax collections and our top earners aren’t as badly treated as ScoMo wants us to believe.
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Monday, May 14, 2018

How we arrived at budgets we can't trust

After last week’s appalling effort, the resort to misleading practices in the budget is reaching the point where the public’s disrespect and distrust of politicians are spreading to the formerly authoritative budget papers.

We’re used to spin doctors with slippery words. Now it’s spin doctors with slippery numbers. They’re not just gilding the lily, they’re creating an unreal world where the truth is concealed.

It gives me no joy to be telling people not to believe what they read in the budget papers. I’d rather tell them that of course the budget figures can be trusted, and they should heed the advice of the nation’s most senior and respected economists.

I have great respect for most of our econocrats who, at base, care about our economic success, try hard to make their estimates realistic and are at pains to avoid saying things that could mislead.

The problem is that a politicised and demoralised public service is under continuous pressure to help their political masters mislead the public.

The truth about this budget is that a government that’s had surprisingly little success in reducing the budget deficit and halting the growth in its debt decided to ignore its solemn commitments to “bank” any improvement in its position and to achieve a surplus of 1 per cent of gross domestic product “as soon as possible”. Rather, it would have a big tax cut, largely for political reasons.

This should have led to a noticeable delay in the timing of the return to surplus and delay before the debt started going down rather than up.

Instead, we were presented with a budget purporting to show a faster return to surplus despite the tax cut. We could have our cake and eat it.

How was this miracle performed? By an unexpected actual surge in tax collections that was probably a one-off, but was taken to presage a continuing improvement.

Plus overly optimistic forecasts of economic growth, combined with the magic of medium-term projections assuming continuous strong economic growth out to 2028-29.

In the former Labor government’s last budget, of 2013, Wayne Swan introduced two hugely expensive “legacy” programs: the National Disability Insurance Scheme and the Gonski needs-based school funding.

Swan made the schemes seem affordable by phasing them in exceptionally slowly, with the bulk of the cost crowded into the two years immediately following the four years of the “forward estimates”, where they couldn’t be seen.

Even so, he provided “medium-term projections” out 10 years to 2023-24, which showed the budget deficit projected to return to balance in 2015-16, before soaring to a surplus way over 1 per cent of GDP just three years later. Net debt would peak at 11.4 per cent of GDP in 2014-15, then fall to zero in seven years.

The two graphs showing the budget balance soaring up to surplus and the net debt gliding down to zero are truly inspiring and worth looking up (page 3-32).

To Swan, these projections were proof positive that his expensive new spending programs were “fully funded”.

After Labor’d been thrown out, a senior econocrat reproached me for failing to detect that these fabulous projections relied for their magnificence on a “magic asterisk”. Huh? An assumption that real growth in spending would be held to 2 per cent a year, on average.

Swan claimed in successive budgets to be achieving the 2 per cent cap. He never did, in any year. But the “on average” allowed him to claim advanced credit for good intentions in future years.

This year’s is the Wayne Swan Memorial budget. It uses just the same tricks to create just the same illusions.

You promise tax cuts worth $140 billion over 10 years, but with only 10 per cent of that cost hitting the budget in the first four years of forward estimates, and the remaining 90 per cent hidden by a projection methodology that assumes smooth sailing and Scott Morrison’s claim to be able to achieve unprecedented restraint in spending.

Swan was a master of “reprofiling” – shifting receipts and payments around to keep the budget balance looking like it’s heading in the right direction and disguise the trouble you’re having paying for promises you can’t afford.

This budget’s full of reprofiling, including a one-off draw-forward of tobacco excise timed to help in a tough year and the temporary disinterment of the low-income tax offset so the tax cut can start seven weeks after budget night but not hit the budget until the following financial year.

But the more treasurers use the budget papers to mislead us, the more they foul their own nest, demeaning their great office, discrediting the documents they produce with such flourish, and disheartening the econocrats who used to be proud to work for Treasury.
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Saturday, May 12, 2018

Budget assumes a kinder, gentler world

Have you heard the one about a physicist, an engineer and an economist stranded on a desert island, with only a can of baked beans to eat?

The two science-types spend ages arguing about the best way to get the beans out of the can without wasting any, until the economist is exasperated. “It’s simple,” he says. “Assume a can-opener.”

Don’t laugh. That old joke (which I first heard from Professor John Hewson) tells you a lot about how economists think and a lot about how this week’s budget was put together.

On its face, it’s an impressive document. Despite its promise of tax cuts for everyone, stretching over seven years, it forecast just one more financial year of underlying cash deficit before the budget moved to a (tiny) surplus in 2019-20, projected to grow to $11 billion in 2020-21 and keep growing, year by year out to 2028-29.

Going by what little we were told about nasties, this would be achieved without much in the way of spending cuts.

And here’s the best bit. You thought the government had given up on debt and deficit? Wrong. Wrong. Wrong.

The expected return to surplus in two years’ time means the federal government’s net debt would reach a peak of $350 billion (equivalent to 18.4 per cent of gross domestic product), before all the subsequent annual surpluses were used to pay it down.

By 2028-29, it would be down to $118 billion – an utterly unthreatening 3.8 per cent of GDP. Our children and grandchildren? Virtually debt free.

And how has this unexpected but wonderful turnaround been achieved? Largely by assumption.

Three in particular. First, that despite four or five years of unprecedented weakness in wage growth, wages will immediately begin a steady return to growth of 3.5 per cent a year, without inflation doing anything more than returning to the centre of its target, 2.5 per cent. This does wonders for tax receipts.

Second, the return to strong wage growth means the economy, which was languishing at growth rates well below average as recently as the December-quarter figures we saw two months ago, will, in just seven weeks’ time, have returned to its “potential” growth rate of 2.75 per cent a year. It will then grow at the above-trend rate of 3 per cent in the coming two financial years.

That’s where the actual forecasts stop and Treasury’s much more clockwork-style “projections” take over. They assume that this above-trend growth continues unabated for five years until the economy’s estimated “negative output gap” (spare production capacity) has been used up.

After that, the economy slows to its trend rate of 2.75 per cent a year until 10 years have passed and it’s 2028-29.

Note that the projection methodology assumes away the possibility of the economy being hit by “economic shocks” from the rest of the world or setbacks at home, as well as assuming away the ups and downs of the business cycle.

So our economy’s record 27 years of continuous growth is projected (that is, assumed) to become 37 years.

Projections are pretty much straight lines. Provided the economy is forecast to be growing strongly when the projections take over, it will continue growing strongly for another eight years.

Provided the budget is forecast to be back in surplus before the projections take over, the surplus is projected to keep getting bigger for another eight years.

Meaning, of course, that provided the government’s net debt is forecast to have peaked, the projected continuous stream of annual surpluses will cut it back every year without fail.

And because the debt’s heading inexorably down, while the level of GDP is heading inexorably up, the rate of improvement in our debt position is even more amazing when measured against GDP. Not bad, eh?

That brings us to the third key assumption on which the budget’s wonderful world – the end game for deficit and debt - is based: what economists at the Grattan Institute label as “superhuman” restraint in government spending.

The “projected budget surpluses, in spite of planned tax cuts, are built on herculean spending restraint”, they say.

Although the real growth in government spending is expected to be 2.7 per cent in the financial year just ending, and 3.1 per cent in the budget year, in the following years it will be just 0.2 per cent, 1.1 per cent and 1.9 per cent.

Curiously, the budget papers neglect to tell us the average rate at which spending is projected to grow over the following seven years to 2028-29, but it’s a safe bet it’s either superhuman or herculean.

Determining the budget’s likely effect on the economy isn’t easy when it’s obvious the budget’s main objective is political rather than economic.

There’s an election coming, so Scott Morrison used the budget to ensure it’s fought over that monumental evil, taxation. We face a choice between a low-taxing party and a high-taxing party. You guess which is which.

Morrison claims cutting taxes does great things for the economy but, as we saw in this column last week, there’s little empirical evidence to support this belief, widely held among the well-off.

Even the much-condemned evil of bracket creep is more about politics (will voters turn on the government?) than economic incentives.

But even budget measures with purely political motivations can’t avoid having effects on the economy.

So, according to the way the Reserve Bank judges it – by looking simply at the direction and size of the expected change in the budget balance – from a deficit of $18.2 billion in 2017-18 to one of $14.5 billion in 2018-19, the “stance” of fiscal policy adopted in the budget is “contractionary”, but to an extent so small ($3.7 billion, or 0.2 per cent of GDP) it doesn’t count.

Judged the strict Keynesian way – by looking at the net effect of the discretionary changes announced in the budget for the old and new years – increased spending of $2.2 billion, the “expansionary” stance of policy is also too tiny to matter.
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Wednesday, May 9, 2018

A blue-skies budget

This budget is too good to be true. If you believe Malcolm Turnbull's luck can turn on a sixpence, this is the budget for you. From now on, everything's coming good.

This is the blue skies budget. Things will be so good that we can have everything we want. The government can increase its spending on all the things we want it to provide.

Spending cuts? Perish the thought. In Scott Morrison's words, this budget can "guarantee the essential services that Australians rely on, like Medicare, hospitals, schools and caring for older Australians".

But won't that mean higher taxes? Gosh, no. Quite the reverse. We can cut taxes, starting in little more than seven weeks' time, with more in 2022-23 and more again in 2024-25.

Better, the government can now afford to cap the growth in tax collections at 23.9 per cent of gross domestic product. Every year they threaten to hit that cap it's more tax cuts.

And that's not the best of it. Despite growing government spending on one hand, and tax cuts on the other, the budget deficit will fall in the coming financial year, return to balance the year after, and then begin a string of ever-growing surpluses.

As a result, the government's net debt will reach a peak of almost $350 billion by July next year, then start falling continuously for as far as the eye can see.

Did I mention there's an election in the offing? That's purely coincidental.

It's true that, until the financial year just ending, the Coalition government's economic performance hasn't been all that wonderful. The economy's growth has been below-par, repeatedly slower than forecast.

In consequence, the budget deficit hasn't fallen as far as expected, while government debt has risen faster than expected, repeatedly refusing to reach a peak and start falling.

But not this year. This year the economy has remained slow, held back by year after year of weak growth in wages and, hence, consumer spending.

Even so, there's been inexplicably strong growth in employment, most of it in full-time jobs. This, plus an improvement in export commodity prices and company tax collections, means that, for once, the budget deficit has fallen by a lot more than expected.

The budget-makers seem to have taken this as a sign that it's all looking up. From now on everything's back to normal and the economy will just keep steaming on strongly for another decade.

The economy will return to it's long-term trend rate of growth in the financial year just ending, then grow faster than trend for the following two years. Treasury's more mechanical projections keep this above-trend growth continuing for another two years and, presumably, for the rest of a decade.

Much of this rapid return to "the old normal" rests on the government's forecast that the past four or five years of exceptionally weak growth in wages will end next month. Wage rises will be a lot higher in 2018-19, higher again the following year and still higher, at 3.5 per cent a year, in the following two years and for the remaining years out to 2028-29.

I think this is the basic explanation for the budget's forecasts and projections, prepared by that well-known Italian economist, Rosie Scenario.

A lesser part of the explanation is that, when you examine it, the government's seven-year plan for tax cuts is very much "back-end loaded".

The cuts for low and middle income-earners earning up to $125,000, starting this July and worth up to (read the fine print) $530 a year, won't increase people's weekly take-home pay.

Rather, the first they see of the cut billed as helping make up for the weak wage growth, will be when they get their tax refund cheque after submitting their 2018-19 tax return in more than a year's time.

Over the coming four financial years, the three-part you-beaut tax cut will have a total cost to the budget of a modest $13.4 billion.

That's because the really big tax cuts, aimed at people earning more than - often, a lot more than - $120,000 a year, don't start for six years, July 2024.

I think that's called pie in the sky.

(If you're wondering how someone earning $125,000 can be classed as low-to-middle, relax. By the time your income has reached $125,000, the $530 has been "clawed back" to zero.)

This budget is too good to be true. All the really good stuff is off in the future - up to a decade into the future.

The forecasts and projections ("projection" is a technical term used by economists to mean "I don't necessarily believe this stuff, but you can if you want to") assume the economy will steam on for a decade without missing a beat or encountering any set back.

This further decade of steady expansion will come on top of the economy already being "in its 27th year of consecutive growth", as the government boasts - surely an interplanetary record.

And this from the forecasters whose predictions have been too optimistic at least since Wayne Swan failed to balance the budget in 2012-13. Until this year, when they were too pessimistic.

They convince me that not even Malcolm Turnbull knows what the future holds.
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Monday, May 7, 2018

Whatever Tuesday’s budget holds, it’s sure to be fudged

It’s a sad truth that treasurers and finance ministers almost never avoid using creative accounting to make their budgets look better – or less worse – than they really are. But this fudging often costs taxpayers a lot more.

Governments of both colours, federal and state, have been doing this forever, after the bureaucrats show them how. It’s one of the less honourable services public servants provide their honourable masters.

The move from cash accounting to accrual accounting at the turn of the century should have made fudging harder, but federal Treasury solved that problem by sticking to cash while Finance moved to accrual.

Focusing public attention on the cash budget balance has kept alive the oldest and simplest form of fudge. You can make the new year’s budget deficit look smaller than it really is by taking a payment due sometime in the new year and paying it in the last days of the old year.

Pre-paying a bill of $1 billion in this way makes the comparison between years look $2 billion better than reality.

But such tricks are chicken feed. The most wasteful one is the way state governments have tried to retain their AAA credit ratings by using “public-private partnerships” to conceal the extent of their borrowing for infrastructure.

No one can borrow more cheaply that government, but paying a private developer a premium to do the borrowing at a higher interest rate ensures the government-initiated debt appears on the developer’s balance sheet, not the government’s.

The state “asset recycling programs” promoted and subsidised by the Abbott-Turnbull government are also a product of the states’ worries about their credit ratings. You sell off existing government businesses and use the proceeds to fund new infrastructure spending without having to borrow.

Sounds innocent enough, but in practice state governments haven’t resisted the temptation to maximise the sale price of their businesses by attaching to the sale the right to overcharge their state’s businesses and consumers.

This does much to explain the doubling in the retail price of electricity. The states allowed the private purchasers of their poles-and-wires businesses to abuse their natural monopoly, and let three big companies own generators as well as retailers.

Tuesday night’s budget will be affected by two relatively new forms of creative accounting. One is the way the Turnbull government exaggerates its success in reducing the size and cost of the public service by giving people redundancy payouts, then hiring them back as “consultants” on greatly inflated salaries.

Then there’s the Abbott government’s invention of “zombie measures”. You announce cuts in spending, fail repeatedly to get them legislated, but leave them in the budget’s forward estimates, thus making the projected budget balance look better than it is.

But the biggest zombie measure distorting the budget numbers we’ll see on Tuesday is the government’s repeatedly rejected plan to extend the cut in the company tax rate to big business. This one, however, makes the projected budget balance look worse than it is. The biter bit.

But by far the biggest budget fiddle – one we’ll see more of on Tuesday – is the loophole Treasury built into the budget at the time of the laughably named Charter of Budget Honesty in 1996, when the focus of attention was switched to the “underlying cash budget balance”.

The ostensible purpose was to stop wicked Labor governments understating their deficits by counting the proceeds from asset sales as a reduction in the deficit rather than an alternative way of funding the deficit. Rather than sell a government bond, you sell some of the family silver.

But Treasury defined “assets” narrowly to include physical assets (say, real estate) but exclude financial assets (such as shares in government-owned businesses).

What this means in practice is that spending on an infrastructure project doesn’t have to be counted in the budget deficit provided you set it up as a new business which, once it’s profitable, you intend to sell off.

Great trick, which the Rudd-Gillard government was happy to use to hide the then-expected $49 billion cost of its National Broadband Network.

Trouble is, the contortions NBN Co had to go through to sustain the pretence it would be profitable were sufficient to blight the project long before Malcolm Turnbull began fiddling with it, as my colleague Peter Martin has explained.

But this wasn’t sufficient to dissuade Scott Morrison from using the same trick in last year’s budget to hide the cost of the second Sydney airport and the inland railway by claiming that, in some imaginary world, they’ll be profitable businesses.

Trouble is, you can keep the spending out of your carefully fudged version of the budget deficit, but you can’t keep your additional borrowings out of the government’s accumulated debt. Watch out for more fudging on Tuesday night.
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Saturday, May 5, 2018

Will tax cuts boost the economy? Yes - and no

When politicians seek to win elections by promising tax cuts, they invariably cloak the inducement by claiming it will do wonders for the economy. You’re not accepting a bribe, you’re helping improve things for all of us.

Treasurer Scott Morrison has said that next week’s budget will include cuts in income tax for low and middle income-earners – presumably, to be delivered sometime after the next election. Labor will also be promising tax cuts at the election.

According to Morrison: “Lower taxes will further strengthen our economy to create more jobs.”

But can you believe it? In a narrow, immediate sense, yes.

Particularly at a time when the growth in wages is so weak, low and middle income-earners are likely to spend much of any tax cut that comes their way.

Since the tax cut will be unfunded – that is, it will cause the budget deficit to be higher than otherwise – this increase in consumer spending is likely to add to employment.

But that’s not saying much. If the same increase in the deficit was caused by an increase in government spending, that too would create jobs somewhere in the economy.

So it’s a higher deficit, not lower taxes, that does the trick. It does so at the cost of higher government debt and interest payments, which will have to be paid for later.

As a solution to weak growth in wages, it’s a Band-Aid.

But Morrison’s on about more than just giving the economy a temporary kick-along. He’s arguing that lower taxes make the economy grow better, whereas higher taxes slow it down and cause it to malfunction.

Because, as well as its version of a tax cut, Labor has plans to reduce various tax concessions and so increase tax collections overall, Morrison is arguing that whereas his tax plan would improve the economy’s functioning, Labor’s plan would worsen it.

Now, can you believe that? Well, it makes perfect sense to many big taxpayers. Surely higher taxes discourage people from working as much and from saving as much.

But though it seems obvious, the empirical evidence in support of the theory is surprisingly limited, as the former senior econocrat, Dr Michael Keating, and Professor Stephen Bell, argue in their new book, Fair Share.

They say it’s reasonable to suppose that if taxation is increased beyond a certain limit, it could reduce the rate of economic growth and thereby reduce the government’s capacity to pay for its present activities.

However, they say, “there is little evidence to suggest that most countries are close to the limit after which tax increases would impact negatively on economic growth and be counterproductive”.

If you compare all the developed countries in the Organisation for Economic Co-operation and Development over the last 25 years, you find no simple relationship between the level of taxation and their rate of improvement in productivity.

Despite very big differences in levels of taxation as a percentage of the economy, rates of productivity improvement are similar – suggesting worldwide advances in technology are far more influential that tax levels.

As well, the authors say, taxation’s effect on economic growth depends not just its level, but on the “mix” of different taxes (some are better than others) and also on what you spend the tax revenue on. Spending on education and training, innovation and productive infrastructure could be expected to increase productivity.

Next, if we look more directly at the impact of rates of income tax on willingness to work, the evidence of an adverse effect isn’t strong, they say.

Simple observation reminds us that, in Australia and many other countries, where the top “marginal” tax rate has been cut markedly over the past three or four decades (I used to pay 60¢ in the dollar in the early 1980s), there’s been no noticeable effect on participation in the workforce, nor on the number of hours worked by top people.

Formal economic studies reach similar conclusions. Much US research has found that tax has a weak effect on hours worked by those already in jobs, though the effect on decisions to work is a little stronger.

The US research shows male rates of participation and hours worked are especially insensitive to tax rates, with the strongest effects on married women. This is generally supported by the limited Australian research.

And whereas everyone assumes it's people on the highest marginal tax rate who’ll be most affected, research shows the impact is small. The biggest effect is on mothers deciding when to return to work, or whether to move from part-time to full-time.

Why? Because "secondary earners" (including Mr Mums) have more choice than "primary earners".

As for the effect of tax rates on the desire to save, it too is small. Since different ways of saving are taxed differently (a bank account versus superannuation versus geared investments), the main effect of a tax change is on people’s choice of those different ways.

The main reason popular opinion differs so much from empirical reality is that changes in tax rates have two effects, which work in opposite directions.

Economists call the one everyone focuses on the “substitution effect”. Raising the tax on doing an hour of work makes it less attractive relative to an hour of not working (“leisure”). This creates a monetary incentive to work less (or save less, for that matter).

What people forget is the “income effect”. Raising the tax on a given amount of work means it now yields less income. This creates a monetary incentive to work more so as to stop your income falling. (Or save more to stop your savings growing more slowly.)

Whether the substitution effect is stronger than the income effect is an empirical question – it can’t be answered from theory. The income effect is strong when people have targets for how much they want to earn or to save (for their retirement, say).

We’ll spend coming weeks hearing a lot about the disincentive effects of higher taxes. Much of it will be hot air.
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Wednesday, May 2, 2018

Now for a budget in cloud cuckoo land

Did you hear the news? It’s a budget miracle. Remember all the worry about debt and deficit? Gone. Not a problem. Disappeared. Or, better word – evaporated.

In recent months, revenue has started pouring into the government’s coffers.

According to Chris Richardson, a leading economist from Deloitte Access Economics, the budget’s “rivers of gold” are flowing again. The improvement in the budget has been “humungous”.

And though this year’s budget is still a week away, Treasurer Scott Morrison isn’t denying it.

This time last year, he was telling us another 0.5 percentage-point increase in the Medicare levy – costing about $425 a year to someone on average earnings – was vital to cover the ever-growing cost of the National Disability Insurance Scheme.

Now, however – and thanks to the unexpected miracle – Morrison tells us it won’t be needed.

And far from putting taxes up, he’s discovered there’s room to put them down. The budget will deliver “tax relief to put more money back in the pockets of middle to lower income Australians to deal with their own household and family budget pressures”.

But please don’t think of ScoMo as Santa. Apparently, these tax cuts won’t be humongous. They’ll be quite modest, but they’ll build up over 10 years.

Whether the next election is held this year or in the first half of next year, next week’s budget is safe to be the last before that election.

And there’s little doubt about the ground on which Malcolm Turnbull hopes to fight it: which would you prefer, the tax-cutting, low-taxing Coalition, or tax-raising, high-taxing Labor?

It’s true – sort of. Labor has announced plans to increase tax collections by clamping down on negative gearing and reducing the discount on capital gains tax, by taxing family trusts as companies, by abolishing cash refunds for unused dividend imputation tax credits and by restoring the Coalition’s budget repair levy of 2 per cent of income exceeding $180,000 a year.

As well, Labor wouldn’t proceed with the Coalition’s plan to cut the rate of company tax for big business.

Gosh. But it’s not that simple. Labor does have plans to raise government spending, but these tax measures leave it plenty of scope to offer its own tax cuts to low and middle income-earners. So it plans to raise the taxes mainly of better-off taxpayers, while cutting tax for everyone else.

The main question is whether Labor will content itself with matching Turnbull’s tax cuts, or up the ante.

If all this is sounding too good to be true, it is. Our problem with deficit and debt hasn’t suddenly gone away. What’s departed is the government’s worry about it.

So we seem about to conduct an election in cloud cuckoo land. Let’s forget our financial troubles and have a tax-cut bidding war. Won’t that be a nice change. (And not to worry, we’ll come back to earth after  the election. Mind the bump.)

It’s true there’s been a significant unexpected improvement in tax collections, but much of that’s likely to be a one-off.

It still leaves the budget in deficit this financial year and the coming one, plus the year after, so we return to a paper-thin surplus in 2020-21, as long promised. We still face the prospect of 12 budget deficits in a row, with the net public debt peaking at a bit less than $365 billion, and an annual interest bill of up to $15 billion.

And don’t get the idea that once we finally get back to surplus we’ll be right, with annual surpluses gradually paying down the debt. In his book, Fair Share, written with Professor Stephen Bell, the former top econocrat Dr Michael Keating reminds us that, on the government’s own projections, the budget is likely to stay in surplus for only a few years before falling back into ever-widening deficit.

Although the present deficit is equivalent to less than 1 per cent of gross domestic product, the projections from the Intergenerational report of 2015 see it rising inexorably to 6 per cent – about $108 billion in today’s dollars - over the following 40 years.

Why? Because government spending is almost certain to continue growing strongly, for several reasons. Because of the ageing of the population – the number of retirees is growing much faster than people of working age. Because our demand for more spending on health and education is unlikely to abate. And because, with all its additional benefits, new medical technology gets ever more costly.

To be sure, the projections assume that, within a few years, total federal tax collections are capped at 23.9 per cent of GDP. Take away that cap and the growth in the deficit would be much more manageable.

But that’s the point. With the public’s unquenchable demand for more health and education – and our refusal to countenance major cuts in spending being the sorry story of the Abbott-Turnbull government – taxes must continue to rise. Unless we want to stay in a world of ever-rising public debt.

Remember that in the weeks ahead. The tax-cut bidding war the two sides are about to stage will be for their benefit, not ours. A terrific party, with a bad hangover, intended to distract us from the harsh truth that what we want has to be paid for, one way or another.
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Monday, April 30, 2018

Bank inquiry will change the course of politics and policy

The misbehaviour by banks and other big financial players revealed by the royal commission is so extensive and so shocking it’s likely to do lasting damage to the public credibility and political influence of the whole of big business and its lobby groups.

That’s particularly likely should the Coalition lose the looming federal election. If it does, that will have been for many reasons. But it’s a safe bet that pollies on both sides will attribute much of the blame to the weeks of appalling revelations by the commission.

With Labor busy reminding voters of how much effort during its time in office the Coalition spent trying to water down the consumer protections in Julia Gillard’s Future of Financial Advice legislation and then staving off a royal commission – while forgetting to mention the tough bank tax in last year’s budget – the Coalition will surely be regretting the closeness of their relationship.

Some Liberals may see themselves as having been used by the banks, notwithstanding the latter’s generous donations to party coffers. So, even if the Coalition retains office, it’s likely to be a lot more reluctant to be seen as a protector of big business.

A new Labor government is likely to be a lot less inhibited in adding to the regulation of business, and tightening the policing of that regulation, than it was in earlier times.

Should Malcolm Turnbull succeed in getting the big-company tax cut through the Senate, an incoming Labor is likely to reverse it (just as Tony Abbott didn’t hesitate to abolish Labor’s carbon tax and mining tax).

Many punters are convinced both sides of politics have been bought by big business, leaving the little guy with no hope of getting a fair shake from governments.

But that view’s likely to recede as both sides see the downside as well as the upside of keeping in with generous donors. This may be the best hope we’ll see of both sides agreeing to curb the election-funding arms race.

I’m expecting more customers for my argument that, in a democracy, the pollies care most about votes, not money. If they can use donations to buy advertising that attracts votes, fine. But when their association with donors starts to cost them votes, they re-do their calculus.

The abuse of union power during the 1960s and ‘70s – when daily life was regularly disrupted by strikes, and having to walk to work was all too common – left a distaste in voters’ mouths that lingered for decades after strike activity fell to negligible levels.

This gave the Libs a powerful stick to beat over Labor’s head. Linking Labor with the unions was always a vote winner. Every incoming Coalition government – Fraser, Howard, Abbott – has established royal commissions into union misbehaviour in the hope of smearing Labor.

But the anti-union card has lost much of its power as the era of union disruption recedes into history. The concerted efforts to discredit Julia Gillard didn’t amount to much electorally, nor this government’s attempt to bring down Bill Shorten.

From here on, however, the boot will be on the other foot. It’s big business that’s on the nose – being seen to have abused its power – and it is being linked with big business that’s now likely to cost votes.

All this change in the political and policy ground rules just from one royal commission, which may or may not lead to prosecutions of bank wrongdoers?

No, not just that. This inquiry’s revelations come on top of the banks’ longstanding unpopularity with the public and the long stream of highly publicised banking misbehaviour running back a decade to the aftermath of the global financial crisis.

And the bad story for banks, fund managers and investment advisers piles on top of continuing sagas over the mistreatment of franchisees and a seeming epidemic of illegal underpayment of wages to young people and those on temporary visas.

That’s not to mention the way fly-by-operators rorted the Vocational Education and Training experiment, ripping off taxpayers and naive young people alike, nor the mysterious way the profits of the three companies dominating the national electricity market at every level have blossomed at the same time retail electricity prices have doubled.

Times have become a lot more hostile for business, and only a Pollyanna would expect them to start getting better rather continue getting worse. Should weak wage growth continue, that will be another factor contributing to voter disaffection.

Why has even the Turnbull government slapped a big new tax on the banks, tried to dictate to the private owner of Liddell power station and now, we’re told, plans to greatly increase the petroleum and gas resource rent tax?

Take a wild guess.
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Saturday, April 28, 2018

Both sides of politics play along with costly con trick

Since there’s probably more madness to come, it’s too soon to tell how much Donald Trump’s uncomprehending machinations on trade will do to make America’s economy less great, let alone the rest of us. But it’s safe to predict damage to our economy – much of it self-inflicted.

Yes, self-inflicted. It won’t just be what Trump and others do to us, but also the damage we do to ourselves by hitting back in ways that hurt us more than they hurt the other guys.

By reacting emotionally rather than intelligently. By playing to the peanut gallery.

It’s true that our economy loses when other countries try to reduce their spending on our exports by imposing a tariff (import duty) on their citizens’ purchases of those exports.

But for us to retaliate by whacking a tariff on our imports from them – as is the instinctive reaction of almost everyone – just makes matters worse by requiring our citizens (and businesses) to pay more for those imports.

This gut reaction is prompted by people’s unthinking assumption that exports are good, but imports are bad. When you think it through, however, you realise imports are just as good as exports – why would we be so keen to buy them if they weren’t?

And exports are good mainly because we can use the money we make from them to buy imports.

International trade is an exercise in mutual and reciprocal benefits. They gain from buying our exports; we gain from buying their exports.

The gains are greater the more each side concentrates on exporting the things they’re good at and importing the things they aren’t much good at. That is, from specialising in their strengths, then exchanging with others with different specialisations.

Trying to maximise your exports while minimising your imports is like not wanting to take your turn in a playground game. The others will object and exclude you from the game if you won’t play fair.

But there’s more to it than just fairness to others. By trying to reduce your imports you’re seeking to divert your own resources – land, labour and capital - from producing stuff you’re good at to producing stuff you aren’t good at.

A great way to make yourself poorer rather than richer.

But to get back to where we started, how can I be so sure our politicians would be stupid enough to respond to the folly of others by doing something that would merely increase the cost to us?

Because of the knee-jerk reaction of both the Coalition and Labor when Trump first announced his intention to impose a tariff of 25 per cent on America’s imports of steel.

As Peter Harris, boss of the Productivity Commission, reminded us in a speech this week, “politicians on both sides, along with steel company executives, competed to sound alarms and promote the concept of even bigger price imposts on steel users in this country, all in the name of supposedly saving jobs”.

Apart from asking our best mate Don to exempt our steel from the new tariff (which is what eventually happened), the government trumpeted its willingness to ramp up our “anti-dumping assistance”.

It didn’t mention that this would have been the third ramp-up in decade. A ramp-up of a ramped-up ramp-up.

Not to be outdone, the opposition not only pledged support for tougher anti-dumping measures, it also said it was willing to shift responsibility for reviewing applications for “safeguards” tariff increases from the hard-headed Productivity Commission to some other, soft-headed outfit.

Both the anti-dumping and the safeguards provisions are backdoor ways of using excuses to sneak back-up tariffs you’d earlier reduced.

They’re ways of giving special treatment to our tiny and inefficient steel industry. And, as always, at the expense not just of all Australian consumers of steel products, but all the other Australian industries that use steel as an input to whatever it is they’re producing, possibly for export.

The popular delusion is that higher protection against imports hurts only the countries whose exports we’re trying to keep out. The truth we’re never told about is that the cost of protecting our industry is actually picked up by all our other industries.

Protection doesn’t save jobs, it just attempts to save jobs in the favoured industry by reducing jobs in all other industries. It’s a form of income redistribution from the efficient to the inefficient which, in the process, makes our economy less efficient overall.

Great idea. So why do politicians do it? In Trump’s case, because he’s a fool, and takes no advice from people who are smarter. In the case of our politicians, because they’re knaves: they know (if only because our econocrats keep telling them) that protection is a costly con trick, but prefer to humour popular incomprehension.

In its Trade and Assistance Review for 2016-17, published this week, the Productivity Commission models several “scenarios” that could emerge from Trump’s trouble-making, depending on how we and others respond to his provocation.

It finds that, should no country respond to Trump significantly increasing tariffs on imports from Mexico and China, Australia would be little affected.

On the other hand, should an all-out trade war leave all countries (including us) with tariffs 15 percentage points higher than at present, real gross world product would fall by 2.9 per cent. The fall in our GDP would be less than half that.

Should we hold out from the general increase in tariffs, our gross domestic product would actually be a bit higher than otherwise, though our real national income would be a little worse.

Now get this: should we join with the other members of the Regional Comprehensive Economic Partnership – China, Japan, South Korea, India, New Zealand and the ASEAN countries – in refusing to increase tariffs while everyone else was, the effects of a not-so-global trade war on us would be tiny.
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Wednesday, April 25, 2018

What motivates decent bankers to rip off their customers

Amid all the reluctant truth-telling at the banking royal commission, one big lie has yet to be apprehended: shame-faced witnesses keep admitting they put their shareholders’ interests ahead of their customers’. Don’t believe it.

From the chief executives and company directors to those middling managers who seem to be the main ones being sent into the firing line, it’s not the shareholders’ pockets they’ve been so keen to line, it’s their own.

They’ve been jumping whatever hurdles they’ve had to clear to get the bonuses they were promised. Why would you rip off old people’s life savings for any lesser reason?

It’s a safe bet that everyone from the very top to well down has been “incentivised” with performance targets and bonuses. I reckon only the lowly would be lumbered with key performance indicators unattached to extra moolah.

It’s hard to imagine how so many seemingly ordinary, decent Australians were led to do so many unethical, dishonest, even illegal things for so many years without them convincing themselves it was normal bankerly behaviour – “everyone’s doing it; I don’t want to miss out” – and that by achieving the targets their bosses had set them, they were being diligent and loyal employees, worthy of reward.

But though the financial services industry must surely be the most egregious instance of the misuse of performance indicators and performance pay, let’s not forget “metrics” is one of the great curses of modern times.

It’s about computers, of course. They’ve made it much easier and cheaper to measure, record and look up the various dimensions of a big organisation’s performance, as well as generating far more measurable data about many aspects of that performance.

Which gave someone the bright idea that all this measurement could be used as an easy and simple way to manage big organisations and motivate people to improve their performance.

Setting people targets for particular aspects of their performance does that. And attaching the achievement of those targets to monetary rewards hyper-charges them.

Hence all the slogans about “what gets measured gets done” and “anything that can be measured can be improved”.

Thus have metrics been used to attempt to improve the performance of almost all the major institutions in our lives: not just big businesses, but primary, secondary and higher education, medicine and hospitals, policing, the public service – the Tax Office and Centrelink, for instance.

Trouble is, whenever we discover new and exciting ways of minimising mental effort, we run a great risk that, while we’re giving our brains a breather, the show will run off the rails in some unexpected way.

It took a while for someone to come up with the slogan antidote: “Not everything that can be counted counts, and not everything that counts can be counted”. Not everything that’s important is measurable, and much that is measurable is unimportant.

Trust, which the bankers had a lot of, is hugely valuable but hard to measure. They failed to notice the way their sharp practice – their attempt to “monetise” that trust – was eroding it.

And now they are reaping a whirlwind no KPI warned them was coming. If you work in financial services, don’t try measuring “esteem” or “reputation” any time soon.

I’ve long harboured doubts about the metric mania, but it’s all laid out in a new book, The Tyranny of Metrics, by Jerry Muller, a history professor at the Catholic University of America, in Washington DC.

Muller says we’ve been gripped by “metric fixation” which is “the seemingly irresistible pressure to measure performance, to publicise it, and to reward it, often in the face of evidence that this just doesn’t work very well”.

The glaring weakness of metrics and KPIs is how easily they can be fudged. Since most jobs are multifaceted, and you can’t slap a KPI on every facet, the simplest and least dishonest way to fudge is concentrate on those aspects of the job covered by a KPI, at the expense of those that aren’t.

Everyone from the chief executive to the lowliest clerk understands this. So why does the practice persist? Because bosses are just as busy fudging their targets as their underlings are. So long as your fudging helps your boss with their fudge, what’s the problem?

Schools fudge their performance on standardised tests by “teaching to the test” or even inviting poor performers to stay home on test day. Police services improve their serious crime clear-up rates by classing more crimes as less serious, or failing to record every crime reported to them.

Hospitals improve their performance by declining to admit people with complicated problems; surgeons improve their performance rates by refusing to treat tricky cases. Sometimes this means patients with big problems suffer delays in treatment, and maybe die. But this doesn’t show in the indicator.

Muller notes the obsession with measurement can get everyone focused on unimportant things that seem easy to measure and away from important things that can’t be measured. It can divert resources away from frontline producers towards managers, administrators and data handlers.

Worse, using money to motivate people tends to crowd out intrinsic motivation: taking a pride in doing your job well and giving customers or taxpayers value for money. It can distort an organisation’s goals and stifle creativity.

Measurement’s fine, so long as it’s used as an aid to human judgment, not a substitute for it.
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Monday, April 2, 2018

What would Jesus do about tax and government spending?

It’s Easter, so let me ask you an odd question: have you noticed how arguments about governments’ intervention in the economy – should they, or shouldn’t they – often rely on an appeal to Christ’s parable of the Good Samaritan?

No, me neither. Until I read a little book called, The Political Samaritan: How Power Hijacked a Parable, by Nick Spencer, of the British religion-and-society think tank, Theos.

This is my take on what I read.

Polling in 2015 by the British Bible Society found that 70 per cent of respondents claimed to have read or heard the parable, but in case you missed that day at Sunday school, I’ll summarise.

One day a lawyer trying to trap Jesus quoted the Old Testament law to “love your neighbour as yourself”, but asked, who is my neighbour?

Jesus replied with a story. A man was travelling down a road when he was attacked by robbers and left half-dead. A priest came down the road and saw the man, but passed by on the other side. So did a religious functionary.

But next came a Samaritan who took pity on the man, bound his wounds and took him to an inn, where he looked after him. Next day the Samaritan paid the innkeeper to look after the man until he was well.

Then Jesus asked the lawyer which of the three was a neighbour to the man who’d been robbed. “The one who had mercy on him,” the lawyer replied. Jesus told him, “Go and do likewise”.

Politicians have been using this parable to support their arguments at least since British evangelicals were campaigning for the abolition of slavery in the early 1800s. Martin Luther King spoke about the parable at length in his last sermon before he was assassinated in 1968.

George W Bush spoke about it, as did Hillary Clinton. But it’s been a particular favourite of the British Labour Party.

Early in his establishment of New Labour, Tony Blair said: “I am worth no more than anyone else, I am my brother’s keeper [an allusion to Cain and Abel in the Book of Genesis], I will not walk by on the other side. We are not simply people set in isolation from one another . . . but members of the same family, same community, same human race. This is my socialism.”

Blair’s successor as British prime minister, Gordon Brown, son of a Presbyterian minister, said “we are prepared to spend money to help the unemployed; we are not going to walk by on the other side, we are going to help them.’’

In the aftermath of the global financial crisis, Brown said: “In a crisis what the British people want to know is that their government will not pass by on the other side, but will be on their side.”

So, to politicians on the left, the Good Samaritan is the all-purpose justification for state intervention to help anyone anywhere with a problem. It’s about collective responsibility and collective action.

To a politician like Margaret Thatcher, however, it’s about precisely the opposite. The Good Samaritan was an individual; he saw someone with a problem and he acted to help them. He didn’t tell the government to do something about it.

People shouldn’t hand over to the state all their personal responsibility. Point one.

Point two: the Samaritan needed money to be able to help the half-dead man, and he had it. But the more we’re taxed, the less we have to discharge our personal responsibility to others.

So what was Jesus really saying? First, according to Spencer, he was reacting against the lawyer’s legalism.

Jesus was concerned with following the spirit of the law, not exploiting its letter. And he was saying the law of neighbourly love is the key commandment which, in cases of conflict, overrides other commandments.

The Samaritan was from an ethnic group the other people in the story despised. So neighbours aren’t just the people in our street, our friends, our fellow Australians, they’re everyone, including those we don’t know or don’t like. The parable is relevant to our treatment of other races and asylum seekers.

The world has changed a lot in the 2000 years since the parable was spoken, so I think we should be wary of assuming it speaks definitively about every modern practice. It doesn’t explicitly authorise compulsory state redistribution of income from rich to poor, nor is it condemned. It doesn’t even give the tick to organised charities.

Conservatives are right to emphasise that our personal responsibility for others is fundamental. But I think supporters of collective action may claim that it’s consistent with the spirit of the parable.
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Saturday, March 31, 2018

Competition isn't always as good as we're told

The banking royal commission has many sub-plots. Did you notice the one where a couple of the banks blamed their decisions to keep doing things they knew were dodgy on the pressure of competition?

A chap from Westpac didn’t argue when one of the inquiry’s barristers criticised it for paying “flex commissions” to car dealers arranging loans for people buying cars. The higher the interest rate the dealers could get their customers to accept, the higher the (undisclosed) commission Westpac paid them.

The Australian Securities and Investments Commission has decided to prohibit this practice from November. So why was Westpac persisting with it until then? Because, if it simply stopped doing it off its own bat, it would lose most of its business to competitors.

Another chap, from the Commonwealth Bank, gave a similar explanation for it continuing to base its commissions to mortgage brokers on the size of the loans they organised. If it stopped doing the wrong thing, he said, its brokers would switch to dealing with other banks.

But since it’s a relaxing long weekend, let’s not persist with such a blood-pressure raising subject as the behaviour of our lovely banks. No, let’s just have a calming philosophical discussion about the complications of competition in markets.

Economists like to give us the impression competition is a fabulous thing in any market, all upside and no downside. Competition is something you can never have enough of, they imply.

Don’t believe it. It’s certainly true that a market with no competition – a monopoly – isn’t a great place. Prices are high, service is bad, and when you complain to the company, no one gives a rat’s.

But it doesn’t follow that all competition is wonderful, nor that more is always better. Far from it.

The simple “neo-classical” model of markets assumes a large number of small sellers. The competition between them is so fierce that none of them dares charge a price that’s a cent more than the minimum needed to cover their costs (including the cost of the capital invested in the business, aka profit).

All sellers charge the same price, and if you try selling for a bit more, you sell nothing and go bankrupt.

In the real world, it ain’t so simple. There are various reasons for this, but a big one is the presence of economies of scale – the more you produce, the lower the average cost of what you’re producing.

This allows you to lower your price – which is good for buyers – but, as a consequence, sell a lot more, which is also good for you.

It’s scale economies that explain why so many of our real-world markets are the opposite of what textbooks assume: a small number of large sellers – known as oligopoly. The big four banks are a good example.

When you look at the behaviour of oligopolies you see competition isn’t as wonderful as it’s cracked up to be. Oligopolists compete fiercely against each other, but they compete mainly for market share, and try to avoid competing on price.

According to the economists’ basic model, however, low prices are the key benefit competition brings us. In reality, oligopolists prefer to keep prices and profit margins high by competing via marketing and advertising, including by “differentiating” their products.

Occasionally a firm tries to steal a march on its competitors by innovation – coming up with a product that’s clearly better than the others. Mainly, however, product differentiation involves superficial differences.

Economists preach the virtues of competition because they assume it gives consumers a wider range of products to choose from, which must be a good thing.

But with only a few sellers, competition tends to do the reverse, limiting the choice available. Each firm will have a product range remarkably similar to the others.

This is because the few big firms focus on each other, not the customers. Their goal is not so much to find the magic product the punters will love, as to make sure their competitors don’t get ahead of them. So product ranges tend to be the same.

But how do we explain those two bankers claiming competition prevented them from ceasing dodgy practices? Why wouldn’t a bank want to get itself a reputation for being square with its customers?

Because of another weakness in the economists’ basic model: its assumption that both buyers and sellers know all they need to know about market conditions - an implicit assumption that gaining the knowledge you need to make good choices is easy and costless.

In reality, it costs time and money to be well-informed, which gives sellers (who tend always to be in the market) an inbuilt advantage over buyers, who tend to buy a new car, or change houses, only occasionally.

The first economists to starting thinking such thoughts just a few decades ago ended up winning Nobel prizes for realising that information is “asymmetric”, with sellers usually knowing a lot more than buyers.

In the two cases from the royal commission, the banks and their car dealers and mortgage brokers know about the conflicts of interest caused by their commission arrangements, but customers don’t.

Should one bank decide to stop playing that game, many of its dealers or brokers would have taken their business elsewhere long before the nation’s customers realised it was more trustworthy than its competitors.

Up-to-date economists see this as a class of “market failure” called a “collective action problem”: all the firms in a market realise they’re doing something wrong, or even profit-reducing, but no one’s game to be the first to stop.

The obvious solution is for the government to intervene and ban the practice, letting everyone off the hook at the same time - just as ASIC has decided to do in the case of flex commissions for car dealers. Sometimes competition needs help from a visible hand.
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Tuesday, March 27, 2018

Cheating cricketers symptomatic of our declining standards

I can’t see why people are so shocked to discover our cricketers have been cheating. Surely that’s only to be expected in a nation that’s drifted so far from our earlier commitment to decency, mateship and the fair go.

Such behaviour is unAustralian? We do, or condone, many things that used to be thought of as unAustralian.

There was a time when it would have been unthinkable for Australians to stand by while an elected government physically and psychologically mistreated people whose only crime was to arrive by boat without an invite.

Many of them are fleeing persecution in their own country, but that makes no difference. We even mistreat their children, causing them to have mental illnesses and then refusing them medical treatment.

Last week a government led by Mr Harbourside Mansion dished out another round of punishment to fellow Australians whose crime was to be unemployed or to have split with their partner while having dependent children, making it hard for them to do paid work.

The money to be saved will go just the tiniest way towards paying for tax cuts for big business. Did the rest of us care? Not really.

But let’s not kid ourselves. If governments thought mistreating asylum seekers and being unreasonable to welfare recipients would lose them votes, they wouldn’t do it.

They do it because they believe most voters want them to punish boat people and supposed dole bludgers. Which also explains why both sides of politics are guilty of it.

Lovely people, Australians. (And don’t imagine the rest of the world isn’t realising how unlovely we are.)

But stoop to tampering with a cricket ball? We’d never do something so utterly despicable. A player could have been injured.

Don’t forget that cricketers have money at stake when they decide whether to ease the path to victory with the help of a little sticky tape.

Nor should we imagine they’re the only Aussies yielding to the temptation to bend the rules in pursuit of a bigger bonus. What do you think the royal commission into banking misconduct is about?

I fear we hear about only a fraction of the national franchises that screw their franchisees, who then screw the kids working for them; the many employers paying less than award wages, including those ripping off people on temporary work visas who’re afraid to complain.

They do so because they’ve lost any sense of fairness towards their workers – and because they’re (rightly) confident their chances of being caught are low.

Governments – Coalition and Labor - have been cutting the number of inspectors and auditors in the name of greater public service efficiency.

We’ve become less Godfearing, more individualistic, more materialistic and more self-centred. We’ve become less community-minded, less committed to “solidarity” – where the strong go easy so as to help the weak do better – and less sympathetic to the battling of the battlers (except when we kid ourselves that we are battlers).

We’ve changed the meaning of “professional” to being highly competent in your occupation, whereas it used to mean putting your clients’ interests ahead of your own.

Politics has degenerated into an unending battle between interest groups, in which each seeks advantage at the expense of the rest. Much of the fighting is conducted by a thriving industry of lobbyists.

Even the churches fight like Kilkenny cats for a bigger share of the government handouts to private schools – just so they can afford to teach their children Christian values, of course.

But don’t imagine the greed is limited to businesses and institutions. Almost all of us have a mercenary attitude towards the government, paying as little tax as possible while demanding free public hospitals, subsidised pharmaceuticals, bulk-billed GP visits and much else.

How does all that add up? Not my problem. My problem is paying an investment adviser to tell me the somersaults I have to turn to get the pension and avoid paying tax on my investments.

What I’ve found most surprising in recent days is not money-hungry cricketers but the views of a leading businessman, Harold Mitchell, expressed in this very organ: “I’m an Australian and I pay tax for the good of the country.”

Mitchell tells of being visited by representatives of the Singapore government, who invited him to move his head office there. Their advertised company tax rate was 15 per cent, but he’d get a special offer of 7 per cent.

He declined. “I believe in the Australian system that creates the sort of society that enabled me to build a successful business. Avoiding tax, even if it seems legal, is a very shortsighted ambition,” he wrote.

What’s wrong with the man? What a corporate dinosaur. He claims to have found at least one other rich person who thinks similarly – the Scottish children’s author, JK Rowling.

“I pay a lot of tax, and I feel one of the reasons I stay and pay and why I’m not based in Monaco ... is I think my country helped me,” she's said.

Mitchell even quoted the American jurist Oliver Wendell Holmes’ dictum that “taxes are what we pay for a civilised society”.

Perhaps the problem is it also works the other way: more money-grubbing, rule-bending and tax avoiding are part of a society that’s becoming less civilised.
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Monday, March 26, 2018

We have a bad case of misdirected compassion

Why do so many of us – and the media, which so often merely reflect back the opinions of their audience – feel sorrier for those who profess to be poor than for those who really are?

Last week, on the day after the single dole was increased by 50¢ to a luxurious $273 a week ($14,190 a year), Malcolm Turnbull’s henchmen succeeded in persuading Pauline Hanson’s One Nation to let him give the down-and-out part of our one nation another kicking. (Sorry, my Salvo upbringing is showing again.)

You’ve heard the news that homelessness is much more prevalent than we thought. According to the Australian Council of Social Service, the Senate’s passing of the Orwellian Welfare "Reform" Bill will, in its first year, add to homelessness by cutting off payments to more than 80,000 people.

The bill contains 17 measures that will adversely affect the lives of thousands of the unemployed, single parents and women and children escaping violence.

You’ve never seen such a list of pettifogging nastiness, yielding tiny savings to the budget.

The unemployed will no longer be back-paid to the day they lodged their claim, meaning the longer Centrelink takes to process that claim, the longer the jobless go without (or have to go cap-in-hand to outfits like the Salvos) and the more pennies the government saves.

Let’s hope it doesn’t make lengthening processing times a KPI.

Until now, the legislation has protected people who can’t complete and lodge their claim because they’re in hospital, are homeless, are escaping domestic violence, or are victims of natural disaster or fire. Sorry, such pathetic excuses will no longer be accepted.

Fortunately, Hanson was shamed into reneging on a commitment to remove a small, one-off “bereavement allowance”.

So, were the media up in arms over this gratuitous attack on people who are already below the poverty line – this “cash grab”?

No, they hardly seemed to notice. Perhaps they were distracted by the bitter tears they were shedding over the plight of all those poor self-funded retirees whose unused dividend imputation refunds the evil Labor Party is threatening to steal.

I’m sure there must be a few retireds with genuine cause for complaint, but I didn’t see any among those whose cries of pain were taken up by a righteously outraged media.

Perhaps the problem is that most political reporters are too young to know how retirement income works. Let’s look at Australia’s most self-pitying and grasping group, the self-proclaimed “self-funded retirees”.

What they mean by this term is that they don’t get the age pension. What they fail to mention to naive reporters is that they don’t get it because they’re too well-off to meet the means test – notwithstanding the best efforts of their investment advisers to rearrange their affairs so they do.

What’s the main reason they’re too well-off to get the age pension? Too much superannuation savings. That’s why I see red every time I hear them claiming to be “self-funded”.

They’ve convinced themselves they’re fiscal heroes who are saving the government a fortune by not getting the pension. Rather, they’ve scrimped and sacrificed for decades to amass the super savings they have.

But they’re deluding themselves on both counts. They conveniently forget that their contributions to super were taxed at 15 per cent rather than their much higher marginal tax rate, as were the annual earnings on those tax-concession-enhanced contributions.

And, since 2007, thanks to Peter Costello (who spent his time as treasurer planting time-bombs in the budget), they’ve paid no tax on their super withdrawals.

As a result, a proportion of their super balance is attributable not to their frugality, but to decades of annual tax concessions, plus compound interest on those concessions.

The higher the payout, the higher the proportion of it attributable to tax breaks rather than actual saving. For most of those with super balances high enough to exclude them from the pension, those accumulated tax breaks would greatly exceed the budgetary cost of that pension, sometimes several times over (as in my case).

That’s being “self-funded”?

Another thing the media’s bleeding hearts (middle-class division) don’t know is that since withdrawals from super are tax-exempt, the money that allegedly self-funded retirees have to live on far exceeds the modest “taxable income” they tell you about.

When they cry poor, these comfortably-off people with their hand out don’t tell you their goal is to get sufficient assistance from the taxpayer to allow them to avoid dipping into the capital value of the shares and property they want to hand on intact to their offspring – who are, no doubt, just as deserving as they are.
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