Class war and cognitive dissonance: do the rich pay enough tax?

In the SMH, Jess Irvine has written a post accusing the rich of not paying enough tax. Strong piece. Very clickable, quite memorable, and in places, very reasonable:

“It is right to think that rich people should pay more tax than the poor. Happiness studies show an extra dollar means a lot more to a poor person than a wealthy person. So, we maximise society’s wellbeing when we raise taxes from the rich, rather than the poor.”

In the AFR, an equally strong reply:

Screen Shot 2016-02-15 at 1.50.33 PMThis was written by the gossip columnist though, which suggests The Fin is passing up the opportunity to really take the bait.

All this has me thinking. Do the rich really pay enough tax?

Instinct says “No!”

There is, however, a bit of cognitive dissonance the average policy wonk faces in answering such a question.

Let’s face it. Most of us consider that question by imagining those richer than us paying more. Few readers interpret it as “should I pay more tax?” even though plenty of you find yourselves in a household making over $100,000 a year.

Secondly, the average policy wonk already knows the facts.  (The graphs that follow come from a terrific Productivity Commission report that is just a few months old.)

Those on higher incomes do pay the most tax in Australia.  The few families making $175,000+ a year contribute more total tax than the (far greater) numbers of households making under $100k.

Screen Shot 2016-02-15 at 2.48.55 PMThe tax burden is squarely aimed at the top of the income distribution curve.Screen Shot 2016-02-15 at 2.36.43 PMWhen you look by assets things get a bit more complicated, but the overall trend is still richer people tend to pay more.

Screen Shot 2016-02-15 at 3.29.19 PM Screen Shot 2016-02-15 at 3.27.41 PMn.b. for whatever reason the data above is by group not decile, and the groups aren’t evenly sized. Sorry. Here’s the distribution of actual households across those groups:

Screen Shot 2016-02-15 at 3.26.42 PMOne technique Jess Irvine uses to support her call for more tax on the rich is raising the spectre of widespread income tax rorting.

I wrote about rorting in Crikey last year after we learned 55 people who earned over a million dollars paid no tax in 2012-13. That fact went viral. But it represents just 0.6 per cent of millionaires.

Most income millionaires seem to pay a lot in tax – 93  per cent of them are in a group with an average tax rate of 42 per cent. Another 6 per cent pay an average rate of 35 per cent.

I reckon tax evasion is far more common in corporate tax than income tax. But Irvine’s article says we can’t do anything about that.

She goes on to argue we should institute a land tax. It’s a good conclusion to what has been a fairly odd argument. I support a land tax. I’ve been pleased recently to see it getting a fair bit of attention.

But it doesn’t really follow from her argument.

It seems to me the rich already pay a lot of tax, are fairly honest about it, and don’t actually complain that much. Is that the end of the argument?

I say no.

This “do the rich pay enough tax?” question is just a proxy – an emotive, perhaps even fun-to-think-about proxy – for a question about whether our society is fair.

So, is Australia fair?

That’s a better question, because it allows that bubbling pot of cognitive dissonance to simmer down for a moment.

The answer is probably a qualified yes. It could be fairer still, if we focus on eliminating disadvantage.

We can hold onto the fact the rich pay most tax, and permit the idea society could still be fairer.

There are many ways to eliminate disadvantage, and make society fairer. Minimum wages and strong public health systems are a big part of it.

When we look at America, we see what can happen without them. That is an economy much less fair than the one we experience.

Transfers are another major way to make a nation fairer. A basic income, or minimum income policy would go a long way to making Australia fairer. But I don’t see arguments for hiking taxes on the rich helping create the sort of consensus necessary for that change.

Screen Shot 2016-02-15 at 2.37.21 PMAmong the many charms of minimum wages, public health and transfers is they don’t discriminate. Everyone has access to them. It’s far harder for a Tory gossip columnist to mock the idea of Medicare than the idea of soaking the rich.

So thinking about areas of disadvantage that are important to eliminate seems to be a better way of looking at fairness in the Australian context. If higher taxes are required for such policies to be afforded, precedent suggests they will fall on those with capacity to pay.

Meanwhile thinking about ways to raise the same amount of tax more efficiently is probably the best argument for land tax.

For these reasons, I’d suggest dialing back instinctively appealing arguments the rich should pay more tax, in favour of more targeted arguments about avoiding corporate tax fraud or eliminating disadvantage.

Why people think tax reform is a knife, and why that’s a problem for Australia.

EDITED on Tuesday September 29 to make it better, fairer, more accurate.

My hypothesis is this: A large part of the Australian public does not understand the tax reform “debate” at all. a substantial part of the tax reform debate.

I hypothesise these people are smart, capable and have Australia’s interests extremely close to their heart. But they have no training in tax theory and therefore lack mental models to understand why, for example, Labor’s Chris Bowen, Shadow Treasurer, would be willing to consider cutting corporate tax to 25 per cent.

They just don’t see how tax affects growth.

The most mentally available model of tax is not one where tax is an ingredient in making the cake, but a knife to cut it up with at the end. This matches lived experience. As a worker and consumer, tax happens at the end of transactions. You get paid, then you pay tax. You buy something then you pay GST at the checkout.

So my hypothesis is the concept of tax as an input to the rate of economic growth is not one that is available to most people.

I’ve been thinking about this hypothesis for a while. Today I decided to test it. I chose the following four tax-related articles and read the comments in all of them.

The Age: Malcolm Turnbull halts tax white paper in major reset (163 comments)

Herald Sun: Imbalanced Tax system stunting growth, says Business Council of Australia (7 Comments)

The New Daily: Scott Morrison wants to give us tax cuts (22 comments)

SMH: Scott Morrison: Work Save Invest the Mantra for the new Treasurer (90 Comments).

If people understood that the tax reform was about boosting growth, I expected to see comments engaging on that topic – supporting the link or refuting it, talking about high-tax high-growth countries like Scandinavia, and low-tax low-growth countries too.

If people did not bring this frame of reference, I expected to see the comments focus on other topics, especially distribution.

I read about 280 internet comments. (Which – as you can imagine – meant deciphering a great number of garbled sentences and enjoying an even greater number of insults.)

I coded them according to whether they mentioned growth or output; distributional outcomes; loopholes; or ‘other’.  ‘Other’ accounted for over 200. The remaining results were crystal clear.

tax commentsDiscussion of growth was present in just over two per cent of total responses and was outweighed by discussion of distributional issues about 9:1.

I tried to be generous with the comments I coded as addressing issues of growth. Here’s one:

“The most important thing to do to fix the economy is to get the taxation right! Fact is the economy under Abbott and Hockey was a blatant disaster getting worse!”

Here’s another:

“Penalty levels of taxation combined with high levels of social welfare payments result in deficites, high borrowing costs and a downward spiral of he economy. That is exactly what is happening in Australia. Our economy is headed the same way as the Greek economy. To reverse this Australia needs to increase the incentive to work and invest and reduce the reward for not working.”

In the 61 comments about “loopholes” there were very many along these lines:

“No change in the policies, give the big end of town a tax cut, and spread the burden over everyone with an increase in the GST. Lower income people are worse off as a result.”

Please note that I am not criticising this last comment. Distributional issues are a crucial part of tax policy and that kind of comment is an important input to a well-grounded tax debate.

The point is we do not have a well-grounded tax debate until everyone is on the same page.

The broader tax debate does not address the impact of tax settings on the output capacity of the economy. It is far more focused on fairness.

The “elites” must work to understand the grip matters distributional have on the public imagination. If they still want to press on with tax reforms – and I think they probably should – they need to take two courses of action.

  1. Prioritise matters of distribution in their own thinking. No tax reform will be possible so long as it obsesses on output to the exclusion of fairness. Multinational enterprise tax reform was a very common thread in comments about fairness.
  2. Work to give people the mental models to understand how tax affects output. Without this very little tax reform will be possible at all.

Elites, building a case for reform does not mean repeating the phrase “We need reform!” It’s truistic to the people who understand it, while confusing and annoying to everyone else. It sounds like you’re talking in code, and that implies you’re plotting something.

Instead, talk about “changing tax law so businesses want to do more work in Australia and hire more people.”

If you hector people about tax by saying “it affects investment decisions!” you’re unlikely to cut through. “Investment decisions” sounds like it has something to do with Macquarie Bank.

The comments on the article about Scott Morrison’s “Work Save Invest” slogan showed “investment” was uniformly interpreted as being about buying shares. Many commenters pointed out they couldn’t afford to do that. “Foreign investment decisions” is probably even worse language. It conjures Chase Manhattan and Bank of China conspiring to rip us off.

Talk about economic growth in language people can understand. Use this language even among yourselves, so when it comes time to talk to “real people” it comes naturally.

One way to build capacity in the community is through using metaphors:

  • Tax is not just a knife, but also the yeast that grows the cake.
  • The economy is like a party and tax is adding water to the beer.
  • The economy is like a football match and tax is like adding more umpires ready to blow the whistle at any moment. They disrupt the natural flow of the game.
  • The economy is like a road and tax is traffic lights. If we put in too many in the road won’t be useful any more.

But that can’t be all. The explanation needs stories about business owners who expand their business once their returns meet a benchmark, and how returns are affected by tax. I can imagine an animation. A business owner making a business plan. Every time she does the maths she comes out in the red, until the tax percentage becomes lower. Then she opens her shop and hires some staff.

Understanding a concept requires knowing several mutually-reinforcing stories that illustrate the same point. The Australian people have not heard enough of these stories. And that is why Tax reform is going nowhere.
NB: In todays’ Fin Review, Laura Tingle talks about this exact issue:

Just as the tax reform debate threatened to choke itself on too many conflicting agendas – increasing the GST, lowering company tax, fixing bracket creep, doing something about superannuation tax concessions – our new treasurer has injected a rather important ingredient: the need to define a reason to do it all.Some of the contributors to the AFR Tax Reform Summit this week have made the observation that an organising principle for the tax reform debate has only rarely been seen amid the worthy, but perhaps too often repeated, calls for individual tax measures to be addressed.

The organising principle needs to be a political argument to voters about why you actually need to mess around with tax in the first place. An argument about corporate competitiveness isn’t really going to cut it out in the ‘burbs.

Yes, we all heard Tony Abbott and Joe Hockey talk ad nauseum about “lower, simpler, fairer” taxes. But they were never able to cut through to voters about why this was such a good idea: that it would – or should – help boost and transform the economy. Instead, it just sounded like a bit of conservative government ideology.”

So if Morrison wants to prosecute that case for tax reform he needs to formulate a story that’s as clear as “Stop the Boats” but for a much more complex concept. Good luck Scott.

Here’s a late-breaking caveat I decided to add.

Among the people who appear to not understand the nature of tax reform are a group who understand it perfectly well but oppose it. They fan the flames of the distributional arguments.

They’re not the only self-interested sorts in the debate.

The fact company tax cuts are now widely accepted  as the most growth-crucial tax cuts in our whole economy is very interesting. Of course cutting it would help growth. But at what revenue cost? And why is it #1? Self interest lurks in any issue where facts are complex.

Why we should tax tampons, and everything else.

Tax on tampons is a hot topic, with Tony Abbott and Joe Hockey in major disagreement. The issue was brought into the spotlight via a petition on communityrun.org.

“And how can a bodily function be taxed? Because the government doesn’t consider the tampons and pads we’re forced to buy every few weeks ‘necessary’ enough to be GST-free.

On the other hand, condoms, lubricants, sunscreen and nicotine patches are all tax-free because they are classed as important health goods. But isn’t the reproductive health and hygiene of 10 million Australians important too?”

I didn’t sign the petition, and here’s why

Sanitary items are different from “condoms, lubricants, sunscreen and nicotine patches”, because people already want to use them, and there is no evidence of significant public health risk if usage falls. Also, “necessity” is not the binding criterion for determining what gets taxed – we tax electricity.

“Half the population menstruates and they shouldn’t be financially penalised for it.

If you still aren’t convinced, let’s consider some statistics: on average women, who make up the majority of people who use sanitary products, earn $262.50 per week less than their male counterparts, and they are also statistically at greater risk of living below the poverty line. Furthermore, this tax disproportionately targets those who may already be disadvantaged, that is the homeless and unemployed.

So why force this underpaid, at risk and disadvantaged portion of society to pay more for basic essentials?”

Healthy women menstruate for about half their life. So, less than 25 per cent of the population menstruates. How big is the financial burden of this tax on them?

A 16 pack of brand-name tampons costs $4 at Coles. Let’s estimate a woman spends $10 a month. GST on that adds up to $12 a year.

The number of people who can’t afford tampons because of GST is therefore negligible. The number of people pushed into poverty because of that $12 slug would be small. Most people campaigning against this tax have no trouble affording $12 a year.

So if you want to make a difference to the financial well-being of poor women, this is an indirect and very marginal approach. It comes with real trade-offs – it would cost the government revenue. That undermines the ability of society to support the poor.

Here’s a petition I’d support instead: raising income support payments to a more reasonable level.

WHAT’S REALLY HAPPENING

If this petition is not really about public health, necessity or fairness what’s it about?

People hate paying tax. They really hate taxes they can’t avoid. They then create ex-post reasons why they should not have to pay tax, generally involving the welfare of the wretched. (Their own benefit is merely incidental to the social good they’re pursuing!).

The mining industry showed the way, with its campaign against the mining tax, focused on the health of small towns and communities. The big polluters mimicked this in killing the carbon tax, worrying about the electricity bills of families on the bread-line.

It’s no surprise these tactics have spread – they’re extremely effective!

The crux here is whether there is a link between fairness and avoidability. Is a tax fair only if there’s a way to avoid it?

Unavoidable taxes are the backbone of our revenue raising system. We already raise lots of revenue effectively through big taxes on things everyone agrees are “good,” like earning income and buying clothes. I’ve previously written that we need more taxes nobody can avoid.

Tax theory says not to introduce loopholes. That was the mantra when I worked at Treasury – maintain the integrity of the system. Always use payments to solve problems, because exemptions are not targeted and get exploited.

But perhaps I am out of step with community sentiment.

Hate for (certain) unavoidable taxes goes back a long way – Poll taxes brought down Margaret Thatcher, for example. Also, exemptions to the GST were what bought it enough legitimacy to be introduced.

I sometimes wonder if sin taxes – tax on alcohol and cigarettes for example – are to blame for the way people see tax in general. A lot of people interpret the tax system as a moral agent judging their actions. If I saw all tax as punishment, I’d be furious about paying tax on sanitary items too.

Tax is not punishment, so maybe we should rename sin taxes to something other than taxes. What we should not do is carve up the system with more exemptions.

Exemptions undermine the efficiency of the tax system but also the sense that tax is our common duty.

I see plenty of normal people arguing that big companies that contort themselves to pay very little tax in Australia are “just doing what anyone would do”. The sense that everyone can and will avoid tax at every turn is pervasive.

I don’t mind paying tax because I can see the benefits it brings. (even though I’m quite aware it’s not all spent efficiently.)

“Tax is what we pay for civilized society.” US Supreme Court Justice Oliver Wendell Holmes, Jr.

Thanks for reading this far! If you’d like to agree, disagree or accuse me of obnoxious mansplaining please do so below, and I shall attempt to respond!

The real value of the government’s “phenomenal” $20k asset write off

The government’s small business budget has been a big success, it seems. They got positive headlines about the Budget being stimulatory, and now approval ratings of the PM are back up.

It’s a PR success. And a lot of that is due to attention lavished on the $20,000 tax write-off for small business.

It’s “Phenomenal” apparently.

Get ready for a lot more asset write-off announcements in future. Because they buy the government a lot more headlines than they deserve.

You wouldn’t know this from reading about it, but the “$20,000” asset write off is worth only about $1000.

Here’s why:

The $20,000 is not taken off the tax bill of a small business. Instead it’s a deduction from income – same as when an individual gives to charity.

After a small business takes $20k off their income, they save the 28.5 per cent tax they would have paid on it. 28.5% of 20k is $5700.

That’s the actual value of being able to instantly write off a car or machine from your tax this year.

But here’s the thing. Businesses could always write off asset purchases against their income. They just had to do it more slowly.

Using a depreciation schedule from the ATO website, I calculated how much a small business would have been able to save off their tax under the old rules.

It’s $5700.

The only advantage is that under the new policy, a business can claim all that $5700 in this tax year, instead of claiming it in dribs and drabs over the next decade.

Here’s a graph for how your depreciation works under instant write off versus slow depreciation.

Years since purchase on the horizontal axis.
Years since purchase on the horizontal axis.

We can measure how much benefit instant access to the write-off provides. All we need to do is make an assumption about how small business values money over time. We do that with a discount rate. Lets assume a discount rate of 8 per cent.

If that is the case, the net present value of the flow of money is $4660. Only $1040 less than the value of the money right now.

(If you assume small business is even more patient, the value of the instant write-off is even less. At a 2 per cent discount rate the NPV is $5350 and the net value of the new policy is a mere $350.)

In summary, the government is getting great value from this policy in media coverage terms.

Compare it to another tax break they gave small business in the Budget – a five per cent tax cut for unincorporated businesses. You probably haven’t seen mention of that anywhere.

But this five per cent tax cut (full disclosure, I run an unincorporated business!) is worth even more to the Budget bottom line. That’s it in the blue bubble on the right side – worth $1.8 billion. This graphic was in the glossy brochures journalists got in the Budget lock-up.

budget glossy

It’s one of the most expensive measures in the Budget. And it has barely got a headline. The government will not make that mistake again.

Expect asset write-off thresholds to be even higher in the next Budget as governments seek a headline that says something like $100,000 Asset Tax Bonus for Small Business.

Land Tax is having its annual meek and ineffectual resurgence. Can we give it some oomph?

Land tax is a great tax.

Just today, Treasury released a report that shows how much more efficient Land Tax is than all the alternatives.

land tax

I’ve previously argued that to promote land tax, we should emphasise that it is unavoidable. But I’ve gone cold on that idea.

It is true, but not a great argument when the government is going soft on tax dodgers. It simply encourages people to say we should enforce our existing taxes. [They’re right, we should. But we should have land tax too.]

Today the SMH economics guru Jess Irvine wrote a long and very welcome piece about land tax. But it conflated the hard-to-grasp concept of a low distortion tax with the easier-to-grasp concept of a tax that’s hard to “dodge.”

“Land tax is one of the most efficient taxes for precisely the reason it is unpopular: it is hard to dodge. They know where you live. You can hire as many accountants as you want, but it is difficult  to hide that mansion in Point Piper.”

I found myself wondering why land tax is not on the agenda. And I think I’ve figured out why. The conceptual framework you need to grasp its benefits is not commonly shared. And you can see that by flicking to the hundreds of comments that followed the article.

Screen Shot 2015-04-08 at 12.19.12 pm Screen Shot 2015-04-08 at 12.17.40 pm

The comments on the article were almost exclusively focused on fairness. Fairness is just one of the keys to good tax policy. Efficiency is the other. And there is a gulf of understanding between economists and the general public on tax efficiency, with economists to blame.

To get land tax out there you need to teach people why distortion is bad.

Economics students learn about a model of the economy like this: Trade is mutually beneficial. Taxes prevent trade. Therefore taxes prevent that mutual benefit. The amount of prevention (aka the distortion) is called deadweight loss.

deadweight loss
Deadweight loss from a price ceiling works much the same as a tax. From Wikipedia

The distorting effect of taxes is one of the great insights of microeconomics. It is counter-intuitive and hard to see, because deadweight loss is always a counter-factual. But can we transmit this flash of inspiration and insight from economics to the general public without messing around drawing supply and demand curves, or measuring utility?

A stumbling block is that the purpose of current taxation is so muddled.

We use taxes on “good things” to raise revenue. And we use taxes on “bad things” to change behaviour.

From observing the tax system, it may be unclear why smoking and working are both taxed. Does the government hate work?

The progressivity of the tax system – which I emphasise I support – doubtless contributes to this confusion. Being a low-wage worker, buying healthy fresh food and education attracts lower rates of tax. Being rich, buying luxury cars, eating at restaurants and making capital gains in shares attracts higher rates of tax.

It would be easy for some to see the tax system as a kind of moral agent, punishing bad behaviour and rewarding good. In this scenario, land tax makes no sense.

Explaining that taxes distort behaviour – but we want to minimise that! – is going to be a hard sell when the public sees we use taxes to distort behaviour all the time.

We tax all these things, and you want me to believe that’s because you want to stop some of these things, but you don’t want to stop others? 

Fixing this will be hard. The terminology is a good place to start.

It cannot be helpful to use one word – “tax” –  for both imposts on activities we actually want to encourage, like work, buying goods and services, making profits and owning land; and for things we actually want  to discourage.

I’ll accept suggestions for how we could rename these taxes – Maybe they could be divided into Detrimental but Oh Well, it’s Necessary Taxes and Useful Pricing Taxes (DOWN and UP)?

This distinction would help plant the seed that some – but not all – taxes should be designed in a way that minimises distortion.

The journey to give land tax a fighting chance will be a very long one. The first steps in that journey will be to help give people the capacity to grasp why land tax might be desirable.

Can Mr Hockey be saved by a big idea?

There’s a very interesting article in The New Daily today, about what our Treasurer Mr Hockey might be up to.

It suggests Mr Hockey’s insistence that Australians spend six months working for the government is a deliberate ploy to turn us against income tax, which will dovetail with an idea from the Commission of Audit:

“providing the States with access to part of the Commonwealth’s personal income tax base.”

The Commission expands on that idea like this:

“A further option to increase State source income is a combined Commonwealth-State personal income tax, which could include providing the States with a designated share of personal income tax raised, or allowing the States to levy a State income tax surcharge (with the Commonwealth ‘making room’ so that overall income tax rate need not rise).”

The article‘s logic linking recent statements to this policy idea may be a tiny bit convoluted, but that doesn’t make it necessarily false, and it is well worth remembering that there is a Federation White Paper lurking, due for completion this year.

The first issues paper of the Federation White Paper was released just prior to Christmas (and I mean just, it came out on the 23rd of December). The amount of coverage it got was slightly less than the NORAD Santa tracking radar. Is the idea that the Abbott government going to reform our whole federation as fictional as the man in the red suit?

Maybe it’s the best idea this government has left.  States spend all the money, but can’t raise enough. This is bad from an accountability perspective, and also because it diverts effort to rent-seeking. States spend time scrapping over the GST shares and the conditions on Specific Purpose Payments.

States don’t appear set to introduce a land tax, which I reckon is the only other solution. So giving them the power to raise their own income taxes is a potentially sensible move. This is a classic small-l liberal solution, allowing each state to set the income tax that best suits its needs, and also encouraging competition between jurisdictions. Vertical Fiscal Imbalance could be over!

(I’ve always thought Vertical Fiscal Imbalance was a terrible bit of terminology and it should be known as something more catchy. I quite like calling it the Federal-State Tax Mismatch.)

This could be the high-minded idea that the Coalition need to administer a shock to the electorate, to make people realise they are actually full of ideas, not just a team of cutters. If done right it could deliver positive media alongside well-liked (probably Labor) state premiers.

The only problem now is that the narrative is all but set. Mr Hockey is seen as a hardline right-wing ideologue, so even a rather sensible plan to optimise subsidiarity will likely be seen through that lens. Will Mr Hockey gamble and introduce this idea – doubtless new to many voters and potentially confused with a tax hike – in these conditions?

The man to sell tax hikes to the Australian people … is John Howard.

Australia’s budget is in a spot of trouble. The ABS released its latest Government finance statistics this week and they show a slump in revenue. 

Budget update

 

This, to me, is not a crisis. It’s not good news, but just as you don’t judge a game of football on a 2 minute period, you don’t judge a fiscal situation on a quarter (or even a year, or even a group of years). You ned to judge the fiscal position in the long run.

I’m interested in this high-level measure, the tax-to-gdp ratio. And that’s an interesting thing, with a few moving parts.

Tax to GDP ratio

Treasury has relatively recently begun spruiking it. (This began in the Rudd era, I believe, when he wanted to seem fiscally prudent while spending a lot.) It can be affected by deliberate actions of government, or by shifts in GDP and prices of key exports.

That spike in the red line at the end is now at risk, due to factors beyond the government’s control. In the 2014 Budget, the government announced it would increase revenue as a percentage of GDP, from 23 per cent to 24.9 per cent.

Given the way everything economic and budgetary has come up turds since, the MYEFO is likely to replace this optimistic assumption when it comes out (soon).

A 1 per cent fall in the terms of trade is estimated to have a $2.6 billion impact on the budget, according to published sensitivty analysis. And this week’s national accounts show an 8.9 per cent fall in terms of trade over the last 12 months.

So we’re likely to get a budget deficit that is expanding and a tax to GDP ratio that is falling.

So what should the government do? In the short-run, it should keep spending to prop up growth. But in the medium to long run it needs to do more.

The most senior figure in Australian economics, Max Corden, strips the issues back to their essentials in the Conversation today.

“Given the deficit prospect, the government faces three choices: (1) Run a bigger deficit, (2) raise taxes, or (3) cut government spending… What the government should consider is raising taxes.”

Cutting spending is important where programs are ineffective, or where you’re trimming fat. That is crucial. But it won’t be enough. The Australian people want the government to do more, not less – we want important things like the NDIS and funding childcare and kindergarten.

I’d support raising taxes, slowly and in a clever way, to try to right the structural budget deficit.

This might seem like an impossible PR job for the government. But with the help of one man, it may not be.

John Howard, Prime Minister 1996-2007

The name John Howard is like a magic charm in contemporary politics.  A man who wins four elections  (96, 99, 2001, 2004) gets a lot of kudos in retrospect, even if he had a seriously easy incumbency, bountiful in threats to national security and bumps to government revenue.

Mr Howard presided over an era that saw the tax-to-GDP ratio rise over 24 per cent, even as he gave away income tax cuts as fast as he could. People remember that time fondly. The song that pleaded for us to not take a rose coloured glasses view of his legacy? That record broke.

The man is viewed (wrongly) as a fiscal genius.If I were Joe Hockey, and I was facing up to the fact I needed to to try to sell tax hikes, I’d stick his name on it.

“Reverting to a John Howard era tax-to-GDP ratio” sounds a lot more palatable than simply “hiking taxes.”

Should we tax and subsidise foods?

I’ve been thinking a lot about diet. A doctor changed my regimen just recently and I won’t go into details, except to say that I may have had my last pasta carbonara. Ever.

pork belly sandwich
farewell to you too, pork belly sandwich.

Along with all the time I’ve spent reading labels in the health-food aisle, I’ve been spending time reading about how food affects the human body.

I’ve always considered myself a pretty well-read and savvy guy. I think about food. But there have really only been two things I thought about.

  1. Eating the right number of calories.
  2. Eating fruit and vegetables.

You can see a little example of what I was eating in 2010 at this link:  Lots of fruit, some vegetables, but also lots of chocolate and chips and booze.

tomakin parma
I look at this photo, I see salad.

My diet today is pretty different. One of the things I’ve been reading a lot about is gut bacteria. There is a big link from the bacteria that live in your gut to your overall health. The bacteria do a heap of really important work (like protecting against allergies), and can cause major health problems, not limited to gut problems. They may be involved in a lot of mental illnesses and multiple sclerosis. 

The gut bacteria also respond strongly to diet, so you can change the populations in there by eating differently. But that’s not all. They also help change your dietary choices! So you could potentially create a cycle where you start feeding bugs in your gut, instead of feeding your own body.

The big point I’m going to make in this post is that science keeps moving on. It’s amazing how little we understand about nutrition. Some vitamins were discovered within the last century. And the science remains sketchy on whether vitamin supplements help or hurt people.

If I were designing a tax and subsidy scheme for food, and it was 1990, I’d probably have subsidised low-calorie cola, following the principle that fewer calories are better.

But in 2014 science has found evidence that diet coke changes your gut bacteria in a way that induces glucose intolerance. And advice has changed on wine, chocolate, cholesterol, coffee, bread, etc. The history of nutrition advice is a turbulent one.

I increasingly believe that eating better is a good idea. But I’m also aware that trying to fine-tune people’s diets leads to a risk of making a scientific mistake.

And that’s even before you look at the chance of making a policy mistake. Even for foods that are clearly and unambiguously unhealthy, you need to understand why people eat them before you can succesfully make policy that helps people not to choose them.

This great story from the Atlantic The Inconvenience of Salad covers off on a few of the traps that policy makers fall into.

For example, the idea that the problem is availability of healthy foods – the ‘food desert’ concept. That idea did not get support from a study in Philadelphia, where scientists eagerly tracked fruit and vegetable consumption after the opening of a local store. They found it had no impact.

The Inconvenience of Salad is a really nice feature that follows around a young guy who has opened a business putting salads in mason jars, putting the mason jars in vending machines, and putting the vending machines out in public.

salad vending

The vending machines have to be stocked every single day and I fear the nice young dude who has ploughed his life savings into this venture will be broke soon. In the article he appears to be mortally shocked when someone describes salad like this

“It’s just nasty to me; it doesn’t agree with my taste buds.”

While I was reading the article I kept thinking that the US should subsidise this guy. But then I tried to take a step back. How sure am I the science won’t change? How sure am I the subsidy will make a difference to behaviour?

The answer in both cases is I’m fairly sure. But not certain.

There is a big natural experiment in Australia. We actually do tax (most) processed food but fresh foods are not subject to the GST.

Despite this, I am yet to see a single study showing that the 10 per cent tax difference between the two has led to any change in diet, or in health. Has the study not been done for lack of data? Or because obesity has been rising so fast researchers fear what they might discover? If anyone is aware of such a study, please bring it to my attention!

E-tax: How putting an accountant out of work can make the world a better place

This year, I started using e-tax again.

The last few years I paid an accountant to do my taxes, partly because there was no e-tax for Mac, and partly because I perceived  there would be some great benefit of getting a professional involved.

Having now been on both sides it’s time to announce my conclusion.

E-tax is, for me, a million times quicker, easier and cheaper than using an accountant. (Even though last tax year my affairs were more complicated than ever, having an ABN and business income, a redundancy payment, etc to contend with).

All the information the accountant uses is provided by me – why not just enter it into a system myself? My accountant also bothered me with physical pieces of paper (ugh!) that I had to physically sign (so medieval!). Using an accountant also gave me no hard deadline on doing my taxes – unlike e-tax – so I let it hang over my head til the following May.

When I go to e-tax, the suburban accounting industry takes a hit. They used to make a few hundreds bucks a year from me ($451 last year, I think) but now they make nothing. Doubtless, this hurts.

But this is exactly how productivity increases – painfully. When I find a way to do something more cheaply, it means someone loses a revenue stream.

The money I used to send to the accountants, I can now spend in some other way. It might go on travel, a new bicycle or dinner out at a restaurant. Some other industry will see the upside of this efficiency increase.

The story of the accountant being pushed out of work by a computer program is extremely relevant right now.

“We are now in the second machine age where robots take on mental, as well as physical work, which does encroach on a vast number of jobs” – Erik Brynjolfsson, director at MIT Initiative on the Digital Economy.

Big names are sounding out the warning:

“Software substitution, whether it’s for drivers or waiters or nurses … it’s progressing. … Technology over time will reduce demand for jobs, particularly at the lower end of skill set. … 20 years from now, labour demand for lots of skill sets will be substantially lower. I don’t think people have that in their mental model.” Bill Gates

In their mental model, the jobs are lost and not replaced. That defies centuries of progress. Could this time be different? I doubt it.

reaper
This guy (and many like him) were replaced by a single tractor

What will happen is that people will specialise in doing things only humans can do, or things where having a human do them adds great value.

These will mainly be services, but then we have a strong history in services.

We will not cease to be a social species, so there will be lots of instances in which people are prepared to pay a premium to have a human provide for them. You’ll notice the Sushi train has not yet replaced the waiter and the vending machine has not replaced the barkeeper.

What this means as well is that more and more jobs will be fun and challenging, because they are human-facing. There will be fewer book-keepers and widget makers squirrelled away in the back room never seeing another human.

Instead there will be more barbers, life coaches, counsellors, nail artists, masseurs, tailors, troubadors, baristas, chauffeurs, etc. And that’s only the existing jobs. I bet things you never thought a person could or would outsource will turn into huge industries.

I can imagine a cooking coach in people’s homes, to bridge the gap between eating in and out.  A financial adviser on call in all manner of situations – perhaps you can set up your credit card so you have to dial them up and justify your purchase every time you try to spend more than $100.

There could be cycling leaders who organise a great ride through the best terrain for the day, and make sure you’re not stranded without a spare tube. Experts that come to you to help you “homebrew” beer or make your own yoghurt. Interior designers that help you custom craft your own furniture. Cleaners that do lots of value add, by say, bringing flowers. Dog trainers, cat groomers, budgie psychologists?

Many of these already exist at small scale. The possibilities are limited only by human ingenuity and the human desire to consume. Don’t bet against those forces.

A deficit tax: Now we really do have a Budget Emergency

Tony Abbott is floating a special deficit tax. If you earn over $80,000 you’ll be up for an extra $800 in tax next year.

Here’s four reasons it’s a bad idea, (and one reason it’s not so bad).

1. We do not have a Budget Emergency. Yet. Our deficits are small and our debt is manageable. What we do have is a looming structural trainwreck as health spending rises while labour force participation falls. A short-term Budget deficit tax fixes the non-problem, while ignoring the real problem.Image

2. Raising taxes while the economy is in poor shape won’t help the recovery. Australia’s growth has been meagre and our unemployment rate rising for most of the past few years (with a blip down in April’s numbers). Smart economics says to spend more and tax less when you’re trying to induce a recovery. This is Keynesianism.

3. Keeping the focus of the budget on the deficit (simple, easy to understand, irrelevant) misses the opportunity to make the budget about something important.

4. If we are so allergic to a deficit of a few billion, we may never borrow again. With Australia’s long-term government bond rate at 3.93 per cent, borrowing is cheap right now.  If we are ever to build any infrastructure round here, we need to borrow money. (Infrastructure costs a lot now and pays off in the long run, so if buy it using cash current generations subsidise later ones). Insufficient borrowing will mean the country comes crumbling down round our ears.

BUT

5. It’s hard to imagine Treasury proposing this idea to the government, except perhaps as a second-best alternative to slashing a lot of programs, and only if the government was hell-bent on returning to surplus immediately. Where you do discern the fingerprints of the department is in the progressive design of the tax, that would mainly slug high-income earners:

[It would] “cost earners on $80,000 at least $800 a year rising to an extra $8000 a year for those earning $400,000 a year.”

Hitting the high income earners may work for Mr Abbott politically too. He hurts only people who are likely to vote for him anyway, keeping western Sydney sweet. That means the people with the highest tendency to consumer their income won’t be hurt, so the economic effect of the tax will be more muted than if it were shared equally. 

Apparently there is a backbench rebellion against Mr Abbott’s paid parental leave scheme, which has s price tag of $5.5 billion, and is genuinely not a clever policy. I’ve written before about the economics of cutting it – reducing eligibility from incomes of $150,000 to $100,000 doesn’t make much of a saving – you’d need to be much bolder.

 

People before what kind of profit?

Profit may be the most emotive and most disagreed-on word in the modern political lexicon.

Screen Shot 2014-01-25 at 3.09.41 pm

For some people, it conjures up a deep positive energy. It’s the lacquer of success that tells you your life has not been in vain, a thank you message from the universe.

For others, it’s a totem of greed. It’s the fuel barbarians pour onto the  bodies of the civilised before they burn them all, throw back their heads and howl as the smoke covers the moon.

Both can be right.

Whether you drive a Rolls Royce or a 1990 Subaru with a bumper sticker that says People Before Profit, you need to know this.

There’s two types of profit.

Economic profit (bad), and accounting profit (fine).

(for more: 1 2 3 )

Let me explain.

Accounting profit is what a business makes after it has paid all its staff, all its bills, but before it pays the people who put the money into the business. People who funded the business to start up need a little bit of sugar to keep their money in there instead of putting it in the bank.

Imagine a small business person who delivers things you buy on the internet. She buys a van, putting $30,000 into the business. If that money was put in the bank and got 5 per cent return it would make $1500. So the small business needs to make at least $1500 in accounting profit, on top of paying wages and bills, to compensate the person who funded the business.

That accounting profit is necessary for the business to run. If there’s no accounting profit, the delivery business will shut down, as the delivery woman realises she should sell the van, put the money in the bank, and work for someone else.

(In reality she should be looking for slightly more than $1500 in accounting profit, to help compensate her for the risk of running a business, which is much higher than plonking your cash in a government-guaranteed deposit.)

So, accounting profit is necessary for businesses to exist. The alternative is the business shutting down.

When you see Woolworths Limited reporting a before-tax profit of $3.4 billion on sales of $58.5 billion, some of that is the accounting profit necessary for the share to be worth anything at all.

But some of it might be economic profit. Let’s go back a step.

Us economists think accountants are simpletons. We like to think about opportunity cost.  We think that you should measure your ‘profits’ against the next best use of your money. So economic profit is not the little bit extra you need to pay back the person who funded the business. Economic profit is extra on top of that. If you make a lot of economic profit, something has gone wrong.

Some businesses make enough money that their owners don’t just get a nice 5 per cent return on their investment. They make enough that it rains cash. That’s often economic profit, and it’s a bad sign.

Unfortunately, it’s not always clear if a company’s profit is simple accounting profit or the extra economic profit.  When an company reports profit, it includes some that is necessary to cover the cost of capital, and the gravy.

PROFITLESS

Here’s the thing: under the assumption of perfectly competitive markets, there should be no economic profit in the long run. Businesses should make enough to cover their cost of capital and not any more.

It’s only during deviations from perfect competition, or when market failures creep in that economic profit can occur. Sometimes firms can create economic profit for themselves by behaving in an anti-competitive way. They have an incentive to do that, which is why we have to have competition law.

The most obvious market failure is market power. If a company is part of an oligopoly, or worse a duopoly (Hi Woolworths), or worst of all, a monopoly, then economic profit can be expected to ensue.

CBAThis is why we can be fairly sure the profits of Australia’s big four banks are not simple accounting profits. They operate in a protected space under the four pillars policy.

Australians think there is far more bank competition than there really is.

Of course banks should make enough to compensate the people that own the capital that allows the bank run. But should they make more?

Commonwealth Bank, Australia’s biggest, made $7.7 billion in profit last year.

The value of the Commonwealth Bank is $120 billion at time of writing. It was, at least until recently, in the top ten biggest banks in the world by value, even though it is not in the top ten by assets.

Any industry where all the competitors are making  extra profit on less assets should ring alarm bells. There is almsot certainly economic profit being made, and it is being made at the expense of the customers.

IS THERE NOTHING WE CAN DO?

I’m glad you asked.

A tax design idea is floating around – currently out of favour – called allowance for corporate equity. It is gentle to accounting profits, and starts to snarl and salivate when economic profits are made. As the name implies, it would allow profits to cover the cost of equity [that’s the money the owner put in, or the $30,000 van in the example above]. After that, taxes rise.

Another way of putting that same idea is to say ‘take the mining super-profit tax and apply it across all industries.’

Here’s an excerpt from the Fairfax press, quoting one of my old lecturers, John Freebairn.

“At the tax summit, Melbourne University’s John Freebairn, a former research director of the Business Council, said Australia’s super-profits tax rate might be ”more towards 40 or 50 per cent”. It would only be paid by companies earning ”monopolistic-type rent”. ”And let’s rub it into the banks,” he added. ”They seem to make much higher returns than anyone else.””

But that would not be popular. It’s one reason Wayne Swan ran from the Allowance for corporate equity idea when it had a brief resurgence a few years ago.

But recognising the difference between the types of profit is crucial for anyone who wants to make a difference to society. Tax policy makers know better than anyone else that companies making a super profit are probably managing it at the expense of the consumer. We should not stint from hitting them with extra tax.