Was the great tax debate worth having?

The great tax debate began about a year ago when Joe Hockey, the former Treasurer, released a discussion paper prepared by Treasury. Rather than suggesting a small range of options for consideration, the discussion paper put 66 questions on the table.

The answer that the authors were hoping to be given to some questions was, nevertheless, fairly obvious. For example, when they asked how important is it to reform taxes to boost economic growth, it was fairly obvious that the authors were hoping to told it was important. When they asked how should Australia respond to the global trend toward reduced corporate tax rates, they were probably hoping to be told that Australia should seek to have a tax system that would not deter foreign investment. Information provided in the report implied fairly clearly that there could be economic gains from relying less heavily on company taxes and stamp duties levied by State governments and more heavily on GST and taxes on labour income.

However, the debate had hardly begun before Tony Abbott, the former prime minister, began taking options off the table. He might have had good reasons for that, but he kept them to himself. So, by the time Malcolm Turnbull took over as prime minister, the great tax debate was becoming a fiasco.

Not long after prime minister Turnbull declared that all options were back on the table, the Labor opposition began to claim that the government was intending to raise and/or broaden the GST. The pressure became so intense that the government announced a decision on the matter prior to announcing the tax policy reform proposals it plans to take to the next election. The PM stated:

"After you take into account all of the compensation that you would need to ensure the change was equitable, it simply is not justified in economic terms."

That has elicited a range of responses from economic commentators. The most general response seems to have been that if a GST increase is ruled out, that removes the potential for the government to go to the election with a major tax reform program that would encourage economic growth. Some commentators have suggested that such an outcome was predictable in any case, so there was no point in having the great tax debate.

I don't think either of those responses is appropriate. 

Time will tell whether the government is able to come up with a credible tax reform package that will encourage economic growth. There is potential to do so, but it will require the Commonwealth to transfer back to the States the responsibility for raising more of the revenue required to pay for schools and hospitals. The politics of the federation probably require the Commonwealth to take a leading role in the tax reforms required at state level to enable that to happen. The potential exists for the Commonwealth to play a leading role because the payroll tax was once a Commonwealth tax before being given to the States, in the forlorn hope that they would use it as a growing source of revenue and become less dependent on Commonwealth grants.

Even if the conclusion of the great tax debate is that there are no easy tax switch options to encourage economic growth, that doesn’t mean that the debate was not worth having. If enough people had read and understood the stuff I was writing on this blog (here and here) around this time last year, they might have concluded at that point that there are  no costless taxes and that the focus of the debate should be on how to reduce government spending. Other people were writing similar things - more people probably read and understood some of their contributions - but they still had a negligible impact on understanding of the issues by the general public.

The great tax debate was worth having as a public education exercise. In order for people to persuade themselves to think seriously about ways to reduce government spending they need to bring themselves to understand that there are no costless ways to raise additional government revenue. 

Postscript:
When I wrote this a couple of days ago I had assumed that after the government rejected their proposal to increase GST in order to reduce the company tax rate the Business Council of Australia (BCA) had probably picked up its bat and ball and gone home to sulk for another decade or so . Yesterday, however, they have come back into the game stronger than before. The BCA has now proposed a tax reform agenda that will be difficult for this government to sweep off the table. It is well worth taking a look. 

Could Larry Summers be half-right about secular stagnation?

When I read ‘The age of secular stagnation’ by Lawrence H Summers (published in Foreign Affairs (March/April 2016) I was pleasantly surprised to find that I agreed with part of his analysis.

I agree that economic growth has been relatively weak in most developed countries in recent years because levels of investment have been low, despite high levels of saving and low real interest rates. That is not quite how Summers puts it; he talks about “excess savings”. He might have reasons for that, but it makes his argument seem convoluted.

I tend to agree with Summers when he writes:

“Absent many good new investment opportunities, savings have tended to flow into existing assets, causing asset price inflation”.

My agreement is qualified because I think the absence of investment opportunities is more about perception than reality. Why I think that will become clearer later.

The solution Summers offers to the problem of low investment is an expansionary fiscal policy pursued through public investment. Writing about the United States he argues:

“A time of low real interest rates, low materials prices, and high construction unemployment is the ideal moment for a large public investment program. It is tragic … that net government investment is lower than at any time in nearly six decades”.

It is obviously problematic to be proposing an expansion in public investment at a time when rising government debt has been imposing a significant burden on later generations. But there may be ways around such concerns. In its article, ‘Fighting the next recession’ The Economist (Feb. 20) gave some prominence to the New South Wales Government model of privatising assets such as ports to fund public investment. I had not previously thought of the efforts of the NSW government to raise some cash for infrastructure spending as a model that might have wider application.

However, there are limits to the extent that additional public sector investment is likely to stimulate further private investment. Additional public investment in most economic sectors competes with private investment. If governments confine their investments to sectors where public investment might have a comparative advantage, they will, before long, end up investing in projects that have no hope of yielding even a modest return on investment. Such misallocations seem more likely to add to secular stagnation than to help overcome it. Japan’s efforts to stimulate economic growth by building roads to nowhere may be a good example of such counterproductive public investment.

Before proposing solutions to the problem of secular under-investment it would be a good idea to try to understand why it is occurring. In his recent article, ‘U.S. secular stagnation?’ Steve Hanke pointed to Robert Higgs’ concept of “regime uncertainty” as a possible explanation of the long term downward trend in net private domestic business investment as a percentage of GDP since the beginning of the 1970s. An index of economic policy uncertainty developed by Scott Baker, Nicholas Bloom and Steven Davis suggests that economic policy uncertainty is currently very high - at similar levels to the 1930s, and much higher than in the 50s and 60s.

An increase in policy uncertainty is also consistent with the observation by Kevin Lane and Tom Rosewall (RBA Bulletin 2015) that the hurdle rates of return that firms use to evaluate investment projects has not declined along with declines in interest rates that have occurred since the 1980s. This implies that profitable investment opportunities are being foregone because of greater uncertainty about future after-tax returns and costs. OECD researchers suggest that policy uncertainty (concerning regulation, macro policy and taxation policy) is one factor causing the hurdle rate that companies apply to capital spending to be higher than that applied by financial investors (Business and Financial Outlook 2015, p 60).

My conclusion is that Larry Summers might be about half right in his observations about secular stagnation. Investment has been too low, but the long-run solution can't lie in increased public investment. Governments should be thinking about how they can make businesses feel confident that regulatory and tax burdens are not likely to be further increased over the lifetime of new investments.

How did you react to the appointment of a Minister for Happiness in the UAE?

I chuckled. My initial reaction was that the appointment didn’t seem to be the kind of thing that should be taken seriously. But I wondered what the motives of the UAE government might be.

Some commentators have suggested that the appointment of a Minister for Happiness in the UAE was Orwellian. That sent me looking to see whether Orwell had a Ministry of Happiness in Nineteen Eighty-Four. He didn’t. He had ministries of love, peace, plenty and truth. The distinguishing characteristic of each those ministries was the pursuit of policies that were the opposite of what was implied by the label. For example, the Ministry of Love pursued enforced loyalty to Big Brother through policies of fear and repression.

If North Korea establishes a Minister for Happiness it would be reasonable to presume an Orwellian motive, but I doubt that applies to the UAE.

I am not sure that the Orwellian motive even applies to the establishment of a Ministry of Supreme Social Happiness by president Nicolas Maduro of Venezuela in 2013. His motive was probably to distract people from the decline in their economic well-being, occurring even then as a consequence of the government’s economic mismanagement. It is unlikely that the Ministry is helping people to feel any less miserable as the Venezuelan economy now collapses around them, with falling crude oil prices adding to their woes.

Given the fall in oil prices over the last year, the distraction motive might also help to explain the appointment of a happiness minister in the UAE. The IMF has reduced its growth forecasts for the UAE, even though it is more diversified than many other oil-producing countries in the Middle East. The fall in oil prices is causing fiscal deficits to rise and the government is responding by reigning in government spending. The flow-on effects of this might make life more difficult for the large expatriate community (83.5% of the population) most of whom are from South Asia.

In announcing the appointment of a minister for happiness, the UAE prime minister, Sheikh Mohammed bin Rashid al-Maktoum, claimed that the objective was to "align and drive government policy to create social good and satisfaction". The appointed minister, Ahood Al Roumi, was previously Director-General of the prime minister’s department and will apparently retain that position.

The appointment is part of a government shake-up involving appointment of more young ministers and more females. Women now make up more than one-third of all ministers in the government. The government of the UAE has previously announced the vision for their country to be among the best in the world in the Human Development Index HDI and to be “the happiest of all nations”. The UAE currently ranks 41st of the 188 countries included in the HDI.

It is tempting to dismiss all that as window dressing, but there is a chance that the government of the UAE is actually trying to find a way forward toward a better society. In terms of the “good society” indicators I used in Free to Flourish there is a lot of room for improvement in the UAE, even though it stacks up better than a lot of other countries. Of the 110 countries included in the analysis, the UAE ranks 39^th in terms of peacefulness, 24^th in terms of opportunity and 17^th in terms of economic security.

It will be interesting to observe whether Ahood Al Roumi attempts to use her new role to make the UAE a better society. 

Should foreigners be allowed to buy agricultural land in Australia?

Cartoon by Nicholson from “The Australian” newspaper: www.nicholsoncartoons.com.au

I am surprised by the frequency with which concerns about foreign ownership of land in Australia are being expressed to me by friends who have fairly sensible views on most other issues. It is almost as though rationality disappears whenever foreign ownership and agricultural land become linked in their minds.

My response has been along the lines that foreign ownership of land in Australia isn’t something we should be worried about because it has been occurring since the beginning of European settlement and, these days, accounts for a small proportion of total agricultural land. (ABS data indicate that about 99% of Australian farm businesses are fully Australian owned and about 90% of farmland is fully Australian owned.) 

That usually provokes the assertion that Chinese ownership is new and worrying. 

When I suggest that the new owners can’t take the land home with them, I am asked to justify why foreigners should be able to buy land in Australia, when Australians are not allowed to buy land in their countries. My reply has been that Australia should adopt economic policies that serve the interests of Australians rather than following the policies that other countries adopt. 

At that point I am asked to explain how foreign ownership of agricultural land in Australia serves Australian interests.

That might seem like a reasonable question to ask, but it is actually a debating trick that puts the onus of proof in the wrong place. The basis of a market economy is that economic transactions are undertaken because they are mutually beneficial to sellers and buyers. If some third party considers that a particular kind of transaction should not take place, the onus should be on that party to make the case. 

If an Australian wants to buy the property at a lower price, that is not a legitimate argument for preventing the property from being sold to a foreigner. If their sole objection to the transaction is that the purchaser is foreign, why is that relevant?

Unfortunately, the views I have presented above tend not to have been particularly persuasive. My friends seem to want me to explain how Australians can benefit from foreign ownership of agricultural land. Well, now I have now calmed down a little, I will try to do that.

The most obvious way Australians benefit from foreign land ownership is from associated investments which create increased employment opportunities, and generate additional wealth, some of which adds to government revenues and enables more services to be provided to Australians. 

So, what about the situation where the foreign owner does not undertake any new investment? In that situation it is quite likely that the former owner will invest the proceeds of the sale in ways that will generate additional income. It is also likely that the new owner will find ways to use the resources more productively, perhaps by using better management practices. The fact that a new owner is prepared to pay more than the former owner’s reserve price usually implies that the new owner can see potential to generate more income from the property than the former owner.

Is there any more reason to question the benefits to Australians of foreign investment in agricultural land than any other foreign investment, or of new investment in agricultural land by Australians? I don’t think so, but various arguments to the contrary are raised. It has been suggested that ownership that is encouraged by foreign governments to improve food security may endanger future food security of Australians. It has also been suggested that enclaves of foreign ownership could have a deleterious cultural impact on rural communities. The people who promote those views seem to overlook the fact that foreign ownership or agricultural land in Australia is a small proportion of the total.

The opponents of foreign ownership of agricultural land also raise such issues as whether foreign firms pay tax, whether they are able to import foreign labour more easily, and whether they can be trusted to comply with Australian labour and environmental regulations. Those arguments seem to me to be scraping the barrel. It is hard to see why Australian tax and regulatory authorities should have any greater difficulty in dealing with foreigners than with Australians.

As far as I can see there is no case for foreign ownership of agricultural land in Australia to be subjected to more stringent regulation than any other foreign investment in this country.