A [Working Draft] Response to AFTS Report

Introduction

In May 2007 the Commonwealth Government released Australia's Future Tax System,  Final Report: Overview (and two detailed supporting documents), as well as its response to the review (Stronger, Fairer, Simpler - Australia's Future Tax System Government Response).

AFTS Report

The AFTS Report covered a large range of topics related to Australia's taxation system, and seemed to do so in a workmanlike / competent manner. Several expert observers reacted very favourably to the Report [eg  1]

The comments on the AFTS Report that follow will be mainly concerned with its assumptions about the context in which the tax system will operate, rather than with its analysis or proposals. In particular, the international context may be nowhere near as favourable as the AFTS Report assumes, and fundamental assumptions about other important issues (eg housing affordability; federal fiscal imbalances; and energy cost) also seem suspect.

Commonwealth Government's Response

The Commonwealth Government's initial response to the Report involved:

• introducing significant new taxes on resources' industries (in the form of a resource rent tax, which was labelled a 'Resource Super Profits Tax' - RSPT); and
• directing the resulting increased revenues towards other businesses (eg as tax relief) and the community (as increased business-funded superannuation savings and additional spending particularly on health / hospitals).

The Government's initial response generated widespread controversy. Observers were initially concerned that the Government did not address most of the issues raised in the AFTS Report [eg 1, 2], in relation to which the Government itself stated that a full response would take many years.  However most debate focused on the controversial RSPT .

Examples:

• government did not heed warning about housing affordability [1];
• government avoided broad based reform and instead sought to rebuild its balance sheet at the expense of economy / resource industries [1];
• additional super contributions will deprive manufacturers of cash which they need to build businesses [1];
• tax reform has been deferred while the government rebuilds its balance sheet following spending to deal with GFC [1];
• government has not undertaken simplifications of tax system suggested in Henry report [1];
• government commissioned report is a step towards broad-based economic reform, but its response narrowed to a distributional conflict [1];
• concerns about tax reform strategy include: claims that superannuation increases will hurt jobs; mining industry says taxes don't reflect real world understanding; distribution of mining infrastructure fund [1];
• Review was a first-class public policy document for those interested in Australia's fiscal future. From viewpoint of economy, there would be benefits in implementing it as a whole. Review proposed simple and transparent tax and transfer system. Many recommendations won't be implemented because it is considered that they won't be affordable at present. However many of the productivity enhancing measures (eg cuts to personal and business taxes) would have been a better response to GFC - rather than the large public spending spree that the government undertook. The chief risk with review was that its emphasis on how to increase revenues to close GFC-induced budget deficit, distracted attention from reducing wasteful government spending. The large overlaps in responsibility between federal, state and local governments results in wastage that now needs attention [1];
• Budget inflation forecasts have been suggested to be too low given strong economic growth and full employment (Murdoch S., 'Treasurer playing politics on outlook', Australian, 13/5/10;
• the AFTS review was left and orphan (ie not publicly promoted or explained) after its presentation [1];
• government adopted only 3 of 138 recommendations of tax review. One that was adopted was RSPT which was a theoretically elegant tax model. However it was not, as it should have been, exposed to real-world feedback before being announced [1]

Some observers was expressed serious concern about the RSPT proposal - resulting in vigorous debate:

• proposals to refund state mining royalties are seen as adding to red tape [1];
• the complexity of the RSPT proposal was of concern to some company directors [1] ;
• the budget assumes that adopting the RSPT will increase mining activity  [1]
• Treasury Secretary has denied that RSPT proposal was designed to slow investment in mining industry [1]
• the proposed RSPT is much more radical than a tax on high rates of profits. Rather it makes government into the 40% silent partner in every new and existing mining, oil and gas project [1];
• replacing mining royalties with a super-profits tax is complex. This system (which makes government into partner in projects) would reduce equity requirement for developing projects and leave investment incentives unchanged. But this has the effect of reducing management motivations for increasing productivity. Also this tax would only apply initially to projects that have succeeded, not to those that have failed - as it should in principle (ie it will tax the winners, without funding the losers). The proposal to refund state mining royalties creates incentives for increases in royalties - as SA has already done [1];
• Resource Rent Tax was badly timed - coinciding with Greek meltdown and Wall Street trading chaos. However it proposes increasing taxes on most competitive Australian industry - at the same time that taxes on others are reduced [1];
• China's economy may be unable to sustain demand for commodities - so a super tax on resources might yield little revenue [1];
• The response by mining industry to resource super profits tax will be a capital strike that will cripple state economies in WA, SA and Queensland [1]
• RSPT could increase foreign ownership of Australia's resource industries - because domestic investors would be deterred from ownership as the proposed tax would not be eligible for franking credits on dividends [1];
• given sovereign debt crisis and potential economic slowdown in China, proposed resource rent tax could be a calamity [1]
• the introduction of a RSPT would radically change conditions under which resource investment would be made (as it effectively makes government into a 40% partner in such operations) and its introduction raises ongoing concerns about sovereign risk [1];
• removal of provisions for government to reimburse losses on unsuccessful mining investments might create a tax regime that would be acceptable to all parties [1];
• RSPT will eventually result in Australia's government writing a cheque for losses incurred by Chinese government in a failed mining venture. China will be main beneficiary of RSPT as there are two groups of investors in resource projects - those interested in profits (like Australian mining companies) and those interested only in resource security as part of economy as a whole. The RSPT is good news for the latter because it makes resources cheaper and includes refunding losses on unsuccessful ventures. China is the world's largest resources user, and focuses on resource security rather than profits [1].
• Treasury secretary, Ken Henry, yesterday defended the government's proposed resource profits tax, saying it would boost the mining industry and the economy despite warnings from companies such as BHP Billiton that it would force projects overseas [1].
• Ross Garnaut seeks changes to proposed RSPT related to Treasury assumptions for guarantees on project losses and the cost of financing new projects. WA Treasury warned that tax could severely undermine state's economy. Garnaut questioned whether future governments under financial pressure would cover costs of project losses, and whether mining projects could attract finance at government bond rate (Shanahan D etal 'Garnaut backs mine tax changes', Australian, 21/5/10)
• Treasurer needs explain RSPT or else it will become another ETS - as there are many questions about it (Cohen B ' Mr Treasurer, we have a few dozen questions', Australian , 21/5/10)
• The resource tax rebate on loss-making enterprises may favour China. Chinese investor seeking resource security could be major beneficiaries of RSPT according to president of Australia China Business Council in WA (Duncan Calder). Lower profits available to investors would not be a problem for Chinese investors with downstream processing operation. Under the proposed tax China would face less competition for projects from rival sources of capital (Burrell A 'China could reap rebate on mines', Australian, 22-23/5/10
• Treasury Secretary provided a theoretically elegant defence of RSPT - arguing that it would not discourage investment because the effect of the tax is to split investment into two halves - 60% involves corporate profits and 40% involves government as partner, on which company would be guaranteed a return equal to government bond rate. However this is ivory-tower nonsense, as companies won't be willing to use capital in ways that generate only government bond rate. (McCrann T. 'Henry's elegant nonsense', Australian, 22-23/5/10)
• Budget expects return to surplus in 3 years - and relies heavily on proposed RSPT. Treasury believes that loss of some mining projects could have macroeconomic benefits for Australia, but reducing pressure on economy, and thus need for rises in interest rates. It would also reduce the problem of managing a 2 speed economy. (Shanahan D etal 'Mining delays not all bad', Australian, 13/5/10 )
• Treasurer told mining industry to cease public complaints about proposed RSPT and engage in private with government. But when companies did so, they discovered that committee was only empowered to discuss implementation of the tax (in effect seeking information from companies that would disadvantage them) (Stevens M 'Stunned by Swan's committee', Australian, 13/5/10);
• Government considers that 40% RSPT would help manage economy - because reduced mining investment would make it less necessary for RBA to raise interest rates. Also the queue of mining projects waiting development is considered too large for the economy to handle. (Stutchbury M 'Canberra doesn't mind if a few miners get shafted', Australian, 13/5/10)
• Federal Treasury has argued the case for resource rent tax in terms of reducing problems associated with two speed economy, while moderating the boom and making it more sustainable (Cleary P 'Treasury tries to tame the resource curse', Australian, 15-16/5/10);
• Government has not fully explained its RSPT proposal. Budget papers reveal Treasury diagnosis of how mining can sometimes lower long term economic growth. Not all resource rich countries can turn resource wealth into sustained economic performance (eg because of rent-seeking corruption, and raising exchange rates that squeeze out other industries. This problem has mainlky hit developing economies - where democratic governance is weak and corruptible (Stutchbury M 'More discipline needed to turn boom into a blessing', Australian, 18/5/10)
• Ken Henry believes that proposed tax is elegant and efficient. But what seems good in theory has problems in real world. Government now denies that tax would impede mining investment - yet two weeks ago PM aregued that it was intended to benefit whole economy while drawing attention to problems resulting from resource investment (eg driving up value of dollar which hurt other industries; soaking up skilled labour; and costing more for government to support than other sectors). he argued that 40% super-tax would dampen mining investment. Given adverse mining industry reaction, government is now emphasising benefits to smaller more marginal operations of government 40% share of costs and benefits - though the fact that government would pay 40% of losses on failed projects is not a good selling point in raising capital. There was no consultation with mining industry before tax (which no one else in the world has introduced) was announced. Miners were expecting more taxes, and favour replacing state royalties with a profit based tax, but didn't expect: rate of new tax; that it would apply to all mining projects; that it would apply to existing projects; and that definition of super-profit would be set low. (Hewett J 'Miners in lose-lose scenario over super-profit tax, Australian, 18/5/10)
• there is a lot the government could do to reduce mining industry concerns about the RSPT [1]
• the RSPT is too high; risky and will slow investment [1]
• the RSPT has made Australia a much less attractive place for investment [1]
• RSPT is not a tax in the normal sense - rather it is a resource rent  - which is a charge against the value of minerals over and about the costs and normal profits that a mining company would reasonably expect to receive [1]
• Fortescue Metals CEO (Andrew Forrest) warns that China will tighten its grip on Australian mineral industry under planned RSPT. A leading Chinese entrepreneur noted that plans for a major equity investment in a SA project would continue. Local and foreign banks have backed away from financing Fortescue projects because of potential impact of RSPT. But there does not seem to be any Chinese opposition to the tax. China sees the ability of Australian companies to develop mining projects being removed. A Chinese businessman noted that the tax would discourage investment in Australia's mining projects, but those interest in securing raw materials supplies would find investment attractive (Burrell Andrew, 'New tax fortifies China's hold', Australian, 20/5/10)
• there have been counter-arguments for and against the proposed RSPT.  The governments case is that miners have earned huge profits from recent minerals boom, and community should share in this. This is justified as finite resources are being exploited.  Other's have introduced 'super profits' taxes - and it is claimed that the RSPT is 'world leading'.  and should produce few distortions. However detailed of tax have not been resolved, and its introduction phasing in have not been resolved.  Miners argue that tax is too high; long term government bond rate is too low; there is too little scope to deduct expenses; and the reach of tax is too wide. Consensus of economists in the past has been that: super profits tax rates should be low; and government bond rate is suitable for carried forward costs. Also many complex details of such taxes must be in balance for appropriate outcomes to be achieved. The government has not yet got the model right, and it needs reconsideration [1]
• there are many complexities in proposed theoretically-elegant RSPT - and it would be better to seek a second best solution by building on what already exists. Resources boom will end eventually, and future governments be faced with requirements to pay $bn to failed mining venture [1]
• Chinese companies have expressed concerns about the RSPT, and noted that reduced returns would be likely to affect the viability of projects. However their concern is with reliability of supply, rather than the effect on profitability [1]
• Treasury Secretary (Ken Henry) presented the case for RSPT - but this was done at the wrong time ie long after the RSPT had been announced and controversy had developed. [1]
• Chub Witham (Headland Minerals) suggests that RSPT was devised by people with little knowledge of the industry. Three aspects cause concern; it encourages Australia miners to more offshore; opens the door for Chinese domination of exploration in Australia; and will use tax dollars to bail out failed projects (Barrass T. 'Tax may bury locals: explorer' Australian, 25/5/10)
• US expert argues that miners are wrong and that RSPT will lead to just the right level of mining investment - as the (Brown-type) tax is designed to tax the value of the resource itself, not its development. It is better than royalty system because the latter involves government taking tax off the top - without bearing any of the costs of resource development [1]
• the RSPT would affect the types of resource investments that would be made, rather than discouraging investment altogether [1]
• imposing a tax retrospectively as is intended for RSPT would result in serious perception of sovereign risk for Australia (Ralph J., 'Retrospective tax a risk to national sovereignty', Australian, 25/5/10);
• RSPT will make it harder for miners to sustain the boom (Tasker 'Tax threatens to choke off second mining boom', Australian, 25/5/10);
• the basic idea of replacing state royalties with a profits' based tax is valid, but the way the proposal was introduced was disastrous (Kelly P., 'Labor is caught ina Catch-22 of its own making', Australian, 26/5/10);
• proponents of RSPT argue that it amounts to government taking a 40% interest in mining projects - but investors will not be willing to rely on any government undertaking to cover losses on failed projects [1]
• a group of prominent economists has argued that the RSPT proposal is a more efficient way to tax the mining industry, and will not lead to a slowdown in the sector [1]
• Treasury secretary argued against claims that RSPT would be death knell for the sector - as models showed that mining would be profitable under the tax (noting that royalties would be abolished). [1]
• Federal Government is moving towards major changes to its RSPT proposal (eg lift super profit threshold from 6 to 11-12% and withdraw 40% taxpayer-funded contribution to losses) - though mining companies insist that this will not reduce risk to investment in Australian mining [1];
• RSPT is a federal tax grab that the states should reject [1]
• production-based resource royalties are more difficult for mining companies to deal with than profit-based taxes such as the proposed RSPT [1];
• the RSPT as proposed deserves mining industry criticism, because it would not factor in expenses incurred in generating income; unfairly penalises on economic sector; and involves partial nationalization of the resources sector. Similar tax concepts were considered, and rejected, by the Ralph Review [1];
• there is a need for rational and calm debate about RSPT. It is a complex policy issue that has been endorsed by government on the basis of knowledgeable advice. Australia needs to make its own way in the world outside the North Atlantic trade blocs - in a democratic capitalist world in crisis. When a government gives a mining lease, it is giving away state property (just as when it allocates land to a private party), and the community should expect to receive full value for this.  The economic rent reflects that value, and governments should extract it as taxation. It also promotes more equitable income distribution.  The RSPT (a modified Brown tax) needs to be debated properly.  This is a dangerous time, and Australia must restore its capacity to implement policy in the public interest, independently of pressure from sectional interests [1]
• government advertising claims that mining's contribution to government revenue fell from 1/3 of profits to 1/7 in the mining boom. But nibers argue that this only applies if one considers only royalties and ignores corporate taxes - to which the government responds that the latter apply to all companies and are thus irrelevant [1]
• the resource rent tax proposed by Henry review is a modified Brown tax. The latter involved government taking a (say) 40% exposure to resource projects - in terms of both profits and losses. This was modified (because governments don't like paying out on losses) in terms of government allowing losses to be carried forward (increasing at government bond rate) and written off against future losses. However there is a problem in applying this to existing profit-making projects without providing compensation for past loss-making projects. Also the whole arrangement is so complex that no one really understands it fully - so counter-productive changes could easily be made in future [1] 
• low asset valuations because of policy risks give Beijing a golden opportunity to secure its supply chain. China seeks to avoid market fickleness by building its own supply chain. RSPT proposal in Australia causes miners to warn of reduced investment. This involves Rudd Government endorsing the case about 'excess profits' that China's steel-makers have expressed. Under RSPT proposal resource prices would fall - as miners would not pursue profits vigorously to merely pay more tax. And as supply stagnates, China would be able to overcome resistance to its investment in resource projects [1]
• financiers do not like the idea of government as a silent partner in mining projects [1];
• a year ago PM was criticising theoretical models used by neo-liberals, yet now he is using such models as the basis for justifying RSPT [1]
• Henry tax review sought a fairer share of mineral revenues as taxes. Review and government wanted purest form of resource rent tax - a Brown tax - which would distort decisions least. It is a simple tax on cash flows. Government becomes silent partner by quickly refunding its share of negative cash flows and taxing positive cash flows - discounted by return on capital required to justify investment. But they wanted to avoid up-front cost of Brown tax. So an 'elegant' alternative was used - promising to pay governments share of expenses over time as offsets against profits. Government would still be 40% silent partner, but instead of being written off immediately capital spending would be depreciated over time and owners would get interest on their corporate capital (undepreciated capital and unused losses) at government bond rate.  Miners don't like government as silent partner, and having to finance their share of expenses at bond rate. Given failures in 1990s, they fear being hurt by losses by speculators and poor managers. Garnaut points out that Brown tax creates problems for government where large projects require large refunds - and this increases investor risk that politicians may simply change the rules. Henry's claim that firms would be able to finance effective loans to government at bond rate is unrealistic.  Silent partner model also creates moral hazard risk for investors in structured projects at times of downturn - to wind up operations prematurely. This would increase fiscal leverage to the China boom. Garnaut suggests abandoning RSPT and adopting bersion of PRRT. Government needs to examine all these options [1]
• a Chinese investor expressed concern about introduction of RSPT - and planned to seek special exemption because his project required massive upstream infrastructure investment and downstream processing to be viable. The latter need to be taken into account in determining any super-profits tax [1] [Comment: it is understood that profits in mining / processing operations emerge primarily in the mining stage and tend to be much lower in processing, so that unless the whole operation is considered estimates of profits on mining alone would overstate the true picture].
• Head of Future Fund (David Murray) has called for RSPT to be abandoned or overhauled arguing that it robbed future generations and risked Australia's international reputation [1]
• government should impose taxes to redistribute income [1]
• a resource rent tax is the best options for gaining revenue from mineral assets [1]
• Henry review should have taken its own advice and suggested a cash flow tax [1]
• former senior Treasury official has undermined modelling that was the basis of RSPT by disagreeing that China's resource demand will ensure sky-high demand - as 4050% falls in commodity prices are likely long term. Also Access Economics (Chris Richardson) argues that resource rent tax is flawed because it taxes entrepreneurship - whereas Henry review suggested that it was efficient because it taxed immobile capital [1]
• even given expected loosening of RSPT arrangements, Australia's mining industry will die in the longer term because exploration efforts would cease [1]
• if there were a major slump in mining, then the RSPT (which effectively makes government into a 40% partner in mining projects) would result in substantial costs to taxpayers [1]l

• Economists' conference showed support for RSPT in principle - but revealed substantial design problems. It would yield windfall government revenue in short term at expense of long term. Jack Mintz (Uni of Calgary) suggested that there has been no consideration of relationship between RSPT and company tax. The government would be 40% partner in resource projects - but would not pay 40% of company tax. The effect would be to make marginal mining projects non-viable. Applying RSPT to all existing projects would concentrate all revenue gains at the beginning. If it applied only to green-field projects it would generate little revenue for 10 years. Industry Commission tax review had proposed a purer brown tax - under which government contributed 40% of capital costs. RSPT finances government's share of capital from company with interest equal to government bond yield. An up-front contribution would directly confront the likely financial implications for government of tax regime. RSPT proposal would allow government to spend initial windfall - while ignoring potential long term costs. Better arrangement would involve quarantining revenue into fund that was separate from consolidated revenue with yield provided to government only if it is clear that long term obligations could be met (Stutchbury M. 'Tax rigged to yield windfall government revenue', A, 24/6/10)

An when the federal government responded to criticism and transformed the RSPT into a Mineral Resource Rent Tax (MRRT) there were further expressions of concern:

• the concessions made to large mining companies is likely to lead to pressure from many more rent-seekers (Expect a conga line of rent seekers, 5/7/10);
• while the MRRT arrangement will be more economically efficient that what existed before, the backflip over this probably marks the end of microeconomic reform in Australia [1]
• changes to the resource tax involve reducing the rate from 40% to 22.5%; reducing the number of affected companies from 2500 to 32 - yet this is only supposed to reduce tax revenues by 1/8. There is a lack of clarity about what is going on [1]
• mining companies claim that they will pay 2/3 less tax under revised scheme, whereas government expects only a small fall in revenues. There is a significant chance that government will receive no revenue from the tax. Their expectations require significant lifts in sharemarkets. The government was first convinced that it should tax only coal and iron ore - as other minerals were high risk and thus required high returns or they would not proceed. ABARE lifted its forecasts for coal and iron ore prices (which had been the basis of earlier $12bn government revenue estimate) significantly - in line with Treasury's 4.5% global growth estimates (reflecting expectations in December 2009 which have since reversed). Government negotiators were happy to work with these unrealistic estimates as they made new PM look brilliant. If government economic forecats are right, then sharemarkets have completely misread the situation   [1]
  
  
   

International Context:

There is a serious basis for concern with assumptions about the international environment that underpin both the AFTS Report and the Commonwealth Government's response to it.

The AFTS Report's View

The review started by identifying the changes expected over the next few decades with the first involving "a new world economic order based on ever-deepening international integration, with new centres of competition and opportunity increasingly located in close proximity to us;"

Extracts from Australia's Future Tax System: Report to the Treasurer, December 2009 Part One: Overview

"The task

This Review considers how Australia can best structure its tax and transfer system to meet the challenges of the 21st century and to enhance its economic and social outcomes.

Australians face far-reaching change. As we navigate that change, our challenge is to maintain our strengths, sustain our values and fulfil our promise.

The Review looks forward over the next 40 years to mid-century. Through these decades we expect:

• a new world economic order based on ever-deepening international integration, with new centres of competition and opportunity increasingly located in close proximity to us;
• the transformation of business, commerce and personal lives by technological advances, especially in digital electronics and communications;
• ageing of the population, reducing some tax bases and raising the costs of health, aged care and dependency;
• strong growth and cultural diversification of our population, with high demands for economic infrastructure, education and social infrastructure spending;
• deepening stresses between human activities and wider ecosystems, globally and locally; and
  further stresses on housing affordability and pressure on urban amenity.

Unfortunately, we must also assume that the world will continue to present high risks of conflict imposing high security costs.

Our task is to define a tax and transfer system that anticipates and responds to those expectations. We find that much of the key architecture of the existing tax and transfer system, built last century, reflects sound policy frameworks and Australian social values and will still serve us well.

But not all of it will — a range of key reforms would even better equip us for the changing era ahead." [ p xv]

"1.3 The rise of Asia and the shifting centre of world economic activity

The Australian economy is being transformed by the emergence of new centres of competition and opportunity in the region. The shift of the centre of gravity in the world economy towards Asia is reducing the distance between Australia and its export markets, adding considerable value to our natural resource wealth and opening new investment, trade and employment opportunities. However, growth in Asia will also attract globally mobile capital. Australia will need to respond if it is to remain an attractive place to invest The need for reform and do business. Part of this response should be to ensure that the tax system supports investment, allocates resources to their most valued uses and does not inadvertently add to the cost of production through taxes on business inputs or excessive complexity and compliance costs.

With much of China and India at an early stage of catching up with the living standards of the developed world, strong growth in these countries could continue for a long time (see Chart 1.2). It is therefore likely that demand for non-renewable resources will remain strong and underpin, for some time and possibly for decades, a structurally higher terms of trade2 than existed for much of the past 50 years. This view appears to be shared by investors, as evidenced by strong international interest in investing in the Australian resources sector.

It would be a mistake to conclude that the prospect of a continuing high terms of trade would translate into increased wealth for all or underpin a broad employment base. The expansion in the resources sector and a stronger exchange rate will continue to draw  productive resources from other parts of the economy. Policy responses that expand the supply of productive resources in the economy may ameliorate this adjustment and support a more broadly based economy. Tax and transfer policy settings can influence the effective supply of labour and capital through their effects on the incentives to save, invest and work, and by improving the productivity of labour and capital. .....  " [pp6-7]

 

1.4 Increasing globalisation

"With continuing globalisation, tax settings will be of increasing importance for decisions about where capital will be invested, especially for small open economies like Australia.

Many countries are reducing tax rates on business and capital income relative to labour income and consumption. There has been a clear downward trend in statutory company income tax rates, particularly among small open economies (Table 1.1). Empirical evidence indicates that company tax rates matter for investment decisions, particularly investments for which location is not critical, and decisions by firms about where to declare profits and pay tax. ...." [p8]

Australia's Luck in not Guaranteed

However there are potential obstacles to the continued global economic integration and expansion that the AFTS Report takes as a starting point in assuming that Australia's economic prosperity will be underpinned by strong demand for natural resources, especially from its Asian neighbours.

Example: Australian government and mining industry expect that paradigm shift in global resources markets and secular bull market will last for decades. This is based on the view that China's urbanisation is unstoppable, and will be resource intensive. China is urbanising; has a population 1.3bn, 50% of whom still live in countryside but are moving to cities at a rate of 15m pa. The costs of being wrong about this expectation would be high. This is the basis of RSPT proposal by government to seek 40% of super profits. Government no longer believes in property market cycles. But commodity ycle will still apply . Commodity prices are on long term downtrend over thousands of years due to technological advances. This is interrupted at times - usually during periods of industrialization. Also the intense use of commodities in China's industrialization will end eventually - and lead to resumption of downtrend. No one seems to be considering this at all (Wyatt S. 'Blinded by faith in never-ending boom', AFR, 22/6/10)

In May 2010 the most obvious example of a threat to continued global economic expansion involved the risk of a renewal of an international financial crisis associated with unsustainable levels of sovereign debts (especially in Greece and other peripheral European nations).

However this is not the only risk (see Unresolved Problems and Coming Crises in Defending Australia from the Financial Crisis). Other likely difficulties include:

• unresolved problems in financial institutions as a result of past financial instability (some of which started to become exposed in major European banks as the effect of their exposure to sovereign debt problems in southern Europe was considered);
• the fiscal drag on growth due to the debts governments were obliged to incur to rescue their financial systems (a problem that the European sovereign debt crisis will exacerbate);
• over-investment, and the apparent emergence of a property bubble, in China in an attempt to maintain growth in the face of the GFC - which threatens a short-medium term slowdown / recession.

But the most serious risk arguably arises from cultural differences between various societies which analysts (eg economists, political scientists) tend to be unaware of, because of prevailing assumptions about the universality of Western-style institutions. Competing Civilizations (2001) outlines dimensions of significant differences particularly in relation to:

• Western societies which led the world in economic and political modernisation and in the establishment of global institutions, based on individual / collective rationality within legal and financial constraints;
• East Asia  which, led initially by Japan and later by China, is achieving economic modernisation and exerting increasing international influence, based on radically different methods of problem solving (ie consensus within ethnic communities); and
• Islamic societies which form the largest single group yet that have yet to develop workable paths to modernisation arguably because of social constraints on economic change - a problem that currently is the source of international stresses and conflicts.

Continued economic integration and growth is not inevitable, as demonstrated by the failure of 19th century globalization as the prelude to World War I. Similar risks remain partly because economic and political analysts usually take no account of the practical consequences of differences in cultural assumptions (see The Second Failure of Globalization?).

Amongst those practical consequences are:

• differences in assumptions about the economic role that finance should play, which must prevent agreement on international regulations needed to stabilize the global financial system (see Obstacles to Effective Global Regulation);
• a risk that East Asian economic models could fail, because of their dependence on the strength of the US financial system which was compromised by the financial imbalances the 'Asian' models required (see Are East Asian Economic Models Sustainable? and Time May not be on China's Side);
• an incompatibility between prevailing Western-style institutions and the international political and economic structures that might emerge under 'Asian' influence (see Creating a New International 'Confucian' Political and Economic Order and Time May not be on China's Side). Australians would not prosper in a regional environment dominated by the latter, without radically changing their political and economic institutions in ways that are incompatible with their cultural traditions, and which Australia's opinion leaders and political decision makers show no sign of understanding (see Risks to Australia from Asia-illiterate Policy Makers).

The resulting challenge to assumptions in the AFTS Report that Australia's economic prosperity for the foreseeable future will be underwritten by Asian commodities' demand is that:

• there is real risk that East Asian economic models (and thus their demand for resource inputs for peaceful economic purposes) will fail in the medium-long term;
• Australia's federal budget position reportedly depends critically on the high coal and iron ore prices associated with the 'China boom', so considerable adjustments would be needed if this eases [1];
• if those models prove sustainable, and regional economic and political institutions come to be dominated by 'Asian' communitarian traditions, then the economic basis of reforms embodied in the AFTS Report (which involves creating an environment attractive to profit-seeking / 'capitalistic' enterprises) would be inappropriate and inadequate. In particular;
• the Resource Super Profit Tax proposal, which was taken from the AFTS Review and appeared to be the major source of future new revenue the 2010 Federal Budget relied upon, might actually result in a large reduction in overall government revenues from production-oriented 'Asian' investors in Australian resource development, rather than the increase that would be expected if Western profit-oriented mining companies dominate (see RSPT Won't Hurt Miners: But Pity Help Naive Australians) .

There remains a need for such issues to be more fully analysed as the present writer suggested in a submission to the AFTS Review.

This is particularly critical as it seems that the Federal Treasury seems to have accepted the 'this time its different' hypothesis in relation to Australia's resource boom - and this assumption has been adopted also in the federal Governments 2010 budget [1, 2].

Housing Affordability and Australia Banking System

States

There is no reference to state taxation in Henry vision (Syvret P., 'The cash-flow dream', CM, 3/5/10).

A broad based tax on business cash flows could become central pillar of state tax systems - replacing payroll taxes, stamp duties and many other taxes. States would have four areas of taxation: land tax; gambling taxes; congestion / motoring taxes; and cash flow taxes [1]

State governments do not have much stomach for making their taxes more efficient - some suggestions for which were included in Henry Review (eg in relation to payroll taxes, stamp duties on property transactions, taxes on unimproved land values). AFTS review suggested how states could shift from present tax system to one based on broadly-based land tax with no stamp duties [1]

Potentially Large Environmental Costs are Being Ignored: The Peak Oil Issue

Amongst the future issues that the AFTS Report mentions are "deepening stresses between human activities and wider ecosystems, globally and locally".

Such stresses will lead to significantly increased costs noting, for example,

• widespread recognition of limits to available fresh water and soils everywhere in the world (limits which are translating in Australia into the development of expensive desalination plants, and into a need to renew environmental quality in the Murray darling Basin);
• the difficulty meeting the costs of reducing greenhouse gas emissions which many analysts believe pose serious risks of climate change.

While such concerns are recognised in the AFTS Report (eg see Section 1.5, p9), the Report seems to pay no attention to the apparently imminent global peak oil event which could impose very large costs quite soon (ie to change transport systems, and perhaps patterns of urban and regional development, in the event that oil prices rise rapidly and irreversibly as global production peaks).

An 'efficiency dividend' seems an inefficient way of improving the federal government's financial position (email sent 24/4/11)

Richard Willingham,
The Age

Re: ‘Budget broken promise to hit public sector’, The Age, 22/4/11

I should like to suggest for your consideration that imposing an ‘efficiency dividend’ is a most inefficient way of improving the federal government’s financial position.

Much greater gains could probably be achieved by re-emphasizing government’s core role, ie governing. My reasons for suggesting this are outlined below this email. In brief it is suggested that:

• ‘governing’ involves creating frameworks in which others can do things, and governments’ ability to ‘govern’ has been severely reduced in recent decades by efforts to boost efficiency in service delivery through creating what are seen to be appropriate financial incentives;
• the federal government’s financial position could probably be improved dramatically by shifting from trying to ‘do things’ itself, to an emphasis on ‘governing’ effectively (specifically by creating a framework in which state government functions could be undertaken efficiently and effectively). Eliminating distortions associated with federal fiscal imbalances could potentially both: (a) reduce inefficiencies in state government functions – which currently impose substantial costs on the federal government; and (b) increase federal government revenues, by creating a stronger tax base.

John Craig

Outline of Article and Detailed Comments

My interpretation of your article: The federal government intends to impose an ‘efficiency dividend’ on agencies (ie require a 1.25 or 1.5% pa saving while producing the same output). Savings of $1.1bn over the forward estimates are expected. The CPSU (Nadine Flood) argued that enforced savings would adversely affect services, while the acting shadow treasurer (Andrew Robb) accused the government of stealing Coalition ideas for a 2%pa efficiency dividend.

Government’s core role (ie governing) involves creating a framework in which others can ‘do things’ (eg through legislation and regulation). The provision of public goods and services is very much government’s secondary role, though it absorbs most government revenues. While efforts to fix what ails governments in recent years have been focused on microeconomic reforms (ie creating appropriate financial incentives), there are limitations to what these can achieve (see Economic / Financial Criteria: An Insufficient Basis for Policy). Moreover failure to consider this has seriously undermined government’s effectiveness in ‘governing’ (see Neglected Side Effects). The methods that are appropriate for improving the effectiveness of businesses, don’t suit governments because their core functions are quite different.

And the more emphasis is now placed on government’s secondary role of service delivery (eg by a focus on cost cutting) the less likely it is that the competencies and attitudes required to support elected governments in ‘governing’ will be developed in the public sector. The fundamental conflict between boosting government’s ability to do its primary job (ie governing) and penny pinching in doing its secondary job (ie service delivery) is illustrated in Beyond Populist Rhetoric and Applying a 'meat axe' is the problem, not the solution.

This matters because it is likely that the federal government’s financial position could be improved dramatically if it focused more on governing effectively (ie on creating a framework in which others could ‘do things’), rather than on trying to do them efficiently itself.

Australia’s federal fiscal imbalances (ie the imbalance between state responsibility for most service delivery, and the federal government’s receipt of most of tax revenues) appear to impose huge avoidable costs on both state taxpayers and the federal government (as the latter provides the majority of state revenues as grants and special purpose payments). Those imbalances also result in a weaker-than-necessary tax base – and thus much less revenue at any given tax rate.

An Option to Reduce Costs

The distortions and inefficiencies (and thus costs) that fiscal imbalances have long generated in state functions are illustrated in Federal-State Fiscal Imbalances. The latter notes: (a) the inability of states to take real responsibility for, or to be held democratically accountable, for their functions; (b) the enforced centralization of control within states that often separates decision making from those with the knowledge and experience required to make appropriate decisions; and (c) the across the board suppression of initiative, innovation and commitment that results.

The cost of those distortions and inefficiencies (as well as much of the cost of the federal agencies that have been established to duplicate / control state operations) could be saved if the federal government concentrated on ‘governing’ (on creating a framework in which the states could operate effectively, without trying to control the outcomes - see also Vertical fiscal imbalance). This might be achieved by tax system changes to minimize fiscal imbalances, and by establishing (without trying to control the proceedings of) forums in which states could identify options for, and coordinate initiatives, to address issues that affect them all.

And Increase Revenue

However, as well as cost savings, government revenues could be increased without raising (or perhaps while reducing) tax rates by creating a stronger tax base if another distortion associated with vertical fiscal imbalances were eliminated or reduced (ie horizontal fiscal equalization). The latter reduces the incentive of states (who take the lead role in promoting economic development) to take that responsibility seriously (see Economic development incentives).

Increasing economic productivity (and thereby creating a stronger tax base) seems likely to be feasible using methods like those suggested in A Case for Innovative Economic Leadership and Finding Australia's Place in the International Financial System. However this won’t happen unless states are also given financial incentives to ‘govern’ (ie make it possible for others to ‘do things’) rather than stifling development of the economy by seeking political advantages by being seen to ‘do things’ themselves (ie to provide industry ‘assistance’).

In considering ways to improve the federal government’s financial position, there is thus a need to consider more than penny pinching options such as ‘efficiency dividends’. A new emphasis on ‘governing’ (rather than seeking operational control of everything) may well offer far greater financial benefits.

Similar arguments were presented earlier in relation to Queensland’s Government in Efficiency Review Long Overdue and Eliminating Waste Inefficiently.

Reducing the Need for Entitlements in a Competitive Economic Environment - email sent 20/4/12

Hon Joe Hockey, MHR,
Member for North Sydney

Re: As a country, we cannot keep wallowing in debt, The Australian, 20/4/12

Your article points to the obvious fact that the community should not expect to benefit from ‘entitlements’ at the expense of taxpayers, if government faces structural deficits as a result.

I should like to submit for your consideration that:

• It seems very likely, in Australia as in many other EOCD economies, that ‘entitlements’ have become excessive and financially unsustainable (as your article suggested). This problem apparently became firmly established some years ago under a previous government when a surge in federal government revenues associated with an unsustainable boom in asset values (and thus in capital gains tax revenues) was fully committed to reducing taxes and increasing transfer payments;
• While ‘entitlements’ flow to both low and middle income groups, Australia’s system of transfer payments has been particularly effective in providing support to the lowest income segment of the community, and these transfer payments have:
  • reduced the social stresses resulting from income inequality that would otherwise have impacted on those individuals and regions least equipped to cope with economic change in a competitive environment; and thus
  • reduced political obstacles to the microeconomic reforms that have been seen to be important in facilitating economic adjustment;
• Any reduction in ‘entitlements’ needs to be considered in terms of its possible risk to Australia’s ongoing ability to boost economic productivity – eg because of adverse effects on individuals and regions who are poorly equipped to succeed.

These points are developed further in The Long Term Impact of the Global Financial Crisis, which was part of a 2009 submission to the Review of Australia’s Tax System. This included reference to suggestions about how community and market support to potentially disadvantaged individuals and regions might be increased, as both:

• an alternative to reliance on transfer payments from government (ie entitlements); and
• a complement to traditional microeconomic reforms.

John Craig

Overcoming excess costs of superannuation system - a 'new RBL' suggestion - email sent 29/3/13

Mr Bill Shorten
Minister for Financial Services and Superannuation

Senator Mathias Cormann
Shadow Minister for Financial Services and Superannuation

In relation to current debates about the financial sustainability of Australia’s superannuation regime, I would like to suggest that a simple process might be established to limit the maximum size of any individual’s superannuation holdings to that which is required to fund a ‘comfortable’ lifestyle for a couple (ie creating a ‘new RBL’ arrangement).

My understanding is that the cost of superannuation tax concessions is becoming exorbitant largely because the nominal ‘sole purpose test’ of superannuation (ie providing for retirement) is not being respected – and the system has become a means for tax avoidance.

Previous arrangements for trying to prevent this (via a ‘reasonable benefit limit’ - RBL) proved unworkably complex – and were removed. However an alternative might be to:

• Calculate with each budget the amount of superannuation that an individual would require at the official retirement age (eg 65) in order to fund a ‘comfortable’ lifestyle for a couple until (say) 5-10 years beyond the average of male and female life expectancies (eg 25-30 years) – taking into account: (a) expected earnings; (b) expected inflation; (c) normal variations in spending with age; (d) taxation obligations; and (e) eligibility for pensions and other government benefits in later years as superannuation assets were run down. This would be a generous provision (eg because it would allow an individual to fund the needs of a couple – a provision that would be desirable because of the imbalances in superannuation assets that can arise in families). While I have not done the sums it might be that this figure would currently be about $2m (see later $0.75-1.7m estimate below this email);
• at the end of the following financial year, require:
  • the total superannuation holdings be reported through the Tax office for all individuals who have superannuation assets in the accumulation phase that exceed the ‘new RBL’; and
  • the excess to be removed from the superannuation system – with a possible requirement for paying tax at that time depending on how the excess arose. For example, if an excess resulted from earnings in superannuation funds on which tax was paid by the funds or from un-deducted contributions, then withdrawal of the excess should be tax free. If part or all of the excess arose from concessionally-taxed contributions in the previous financial year, then the full tax that would have been payable had those contributions not been made would be payable as the excess was withdrawn;
• allow individuals whose total superannuation assets have exceeded the ‘new RBL’ to opt out of requirements for compulsory superannuation contributions from their employers, and prevent voluntary contributions to superannuation accounts for those whose superannuation assets have exceeded the ‘new RBL’.

While there would undoubtedly be more complexities in such an arrangement than indicated above, it would seem likely that that a fairly simple path to enforcing the ‘sole purpose test’ for superannuation could be found:

• Individuals would be able to plan their affairs with knowledge of the ‘new RBL’ (though the way this would vary in future would need to be estimated in making such plans). 
• The ‘new RBL’ would clearly be and remain a genuinely ‘reasonable’ benefit limit.
• Those whose superannuation benefits were genuinely reasonable would not be adversely affected.
• The penalties for exceeding the 'new RBL' would be reasonable - rather than the draconian tax imposts that used to apply under the 'old RBL' .
• It would be possible to remove constraints on voluntary undeducted contributions to superannuation – as those contributions could never take funds beyond the ‘reasonable’ level for more than a few months.
• It should also be possible to eliminate / minimize elaborate taxation and other regulatory procedures designed to constrain high levels of deductible contributions, as (while some individuals would benefit) the amount of benefits would be quite limited and the superannuation system could probably be made much simpler
• By assigning an imputed value to the accumulated benefits from defined benefit superannuation arrangements it would be possible to extend the 'new RBL' arrangement into such schemes - by transferring any excess into an associated account, paying appropriate tax on the transferred amount and taxing future earnings / contributions at the same rate as would apply if these amounts were taken as ordinary salary. [If  accumulated benefits were merely an employer's contingent liabilities, then tax obligations could also be treated as contingent liabilities - which attract interest until actually paid at the same rate as the account's other contingent assets increase].  This would then eliminate the requirement for special taxation treatment of such superannuation schemes in the pension phase

Regards 

John Craig

Rough Estimate of ‘new RBL’ in 2013: If one assumes that: (a) a comfortable lifestyle initially requires $60,000 pa for a homeowner couple – a figure that declines slowly in real terms by a total of 20% in very old age – though it increases in nominal terms because of 3% pa inflation; (b) superannuation funding in retirement should be provided to supplement the pension for 30 years; (c) all investment assets are in superannuation; (d) those assets earn 5% pa, then the amount of superannuation needed to fund a ‘comfortable’ lifestyle would be about $750,000.

It is noted that the model used in estimating this: (a) relies on data that is now a couple of years out of date; and (b) the model shows that the couple would receive a $10,000 pa part pension from year one – and over 30 years would receive a total pension of $660,000 (in Year 1 dollars – more in nominal terms). Thus a 'new RBL' of $750,000 would in no sense be a basis for 'self funded retirement' - and would involve planning for complete exhaustion of the individual's superannuation balance which could be a problem if they happened to live too long. Something like $1.7m would be required to meet the above spending requirements for a 'comfortable' retirement and still retain the (say) $1m in current dollars needed to be ineligible for any pension payments in very old age.

It is possible (though this has not been estimated) that the total cost to government might be reduced by increasing the ‘new RBL’ above (say) $750,000 ie because this might reduce the pension component of the couple’s lifetime income by more than the tax concessions with a larger ‘new RBL’. Suggestions about the need to consider the impact on pension savings (and some estimates of possible savings) were in Main A. Taxing Super will raise pension costs', The Australian 13/4/13)

The Effect of Geopolitical Changes on Taxation - email sent 9/5/13

Principal Adviser,
Corporate and International Tax Division,
The Treasury,
Langton Crescent,
PARKES ACT 2600

I would like to make a submission in relation to Implications of the Modern Global Economy for the Taxation of Multinational Companies. I note that the discussion paper refers to issues such as: the increased importance of multinationals and intangibles; the impact of the GFC; and profit shifting that puts the integrity of the corporate income taxation at risk, and also that:

“These issues are being considered in the context of broader geopolitical changes. The global economy continues to experience dramatic shifts from the rise of Asia and growing concerns over the fiscal position of some advanced economies following the global financial crisis.”

There is a major issue that needs to be considered that was not mentioned in the discussion paper – namely that some now important economies in East Asia have financial systems that are incompatible with the capitalistic economic practices that are the basis of conventional approaches to business taxation. Those economies (notable those of Japan and China) are mercantilist in the sense of pursuing economic power by maximizing production, rather than capitalistic in the sense that this involves profit-focused investment by independent enterprises – see Evidence.

An attempt to provide an account of those systems is in Understanding East Asia's Neo-Confucian Systems of Socio-political-economy (2009), and the implications of those arrangements for Australia’s ability to impose taxes on corporate profits was suggested in RSPT Won't Hurt Miners: But Pity Help Naive Australians (2010).

Other aspects of this situation include: (a) the relationship between those arrangements and the global financial crisis; (b) their incompatibility with continued global economic growth; and (c) the resulting likelihood of financial crises and political instability / resurgent-militarism in East Asia. These points are explored further in Fasten Seat Belts: Rough Weather Ahead.

Suggestions about managing these issues are included with 'Art of War' Speculations about North Korea's Threats.

John Craig

A Broader Approach to Tax Reform - email sent 31/3/15

Damon Kitney and Sid Maher
The Australian

Re: Business pleads for courage on tax , The Australian, 31/3/15

I should like to try to add value to your useful article by suggesting that the proposed evaluation of options for reform of Australia’s tax system needs to be complemented by other initiatives if it is to achieve its objective. As your article noted the investigation is already quite broad in terms of tax arrangements, with ‘everything on the table’. And it is apparently to be set in the context of a long overdue review of Australia’s federal system – a system under which financial imbalances between the federal and state governments appear to have generated uncertainty, duplication, buck passing, complexity and waste (see Federal Fiscal Imbalances, 2003+).

But attention arguably also needs to be paid to:

• Getting more serious about developing Australia’s economy so that a stronger tax base emerges to increase the revenues available from any given tax rates;
• Increasing the effectiveness of government machinery – and thus reducing the cost of public administration as well as the cost of public goods and services; and
• Reducing the need for some government spending by encouraging the emergence of alternative ways of meeting social needs. 

Constraints on government budgets are widely apparent. The federal budget is in deficit because the resource boom era revenues that were fully committed (eg to tax cuts and transfer payments) have been declining. States appear to have inadequate revenues relative to their functions, and to be forced to consider selling assets that may be subject to serious market failures. And there are various reasons to suspect that the situation could worsen. For example:

• population aging will increase public spending (eg on health and pensions) while the working-age / tax-paying population who have to support this declines as a percentage of the whole;
• environmental costs are increasing;
• international competition constrains tax revenues because: (a) average corporate tax rates tend to be significantly lower than in Australia; (b) Australia’s economy does not have strong competitive competencies in many non-resource related function (see How Durable is Australia’s Luck?); and (c) in diversifying its economy Australia is in competition with emerging economies with rising economic capabilities often combined with lower wage rates and lower public service / transfer expectations;
• the growth of Internet-based businesses raises the prospect of economic activities being conducted in Australia by enterprises that do not have a domestic address – the latter being a conventional requirement for paying taxes;
• there is a not inconsiderable risk of dislocation of the global economy (see An Approaching Crisis) and / or of China’s economy on which Australia has become highly dependent (see Ongoing Uncertainty). Any such disruption(s) would compound the fiscal stresses facing Australia’s governments.

In addition to possible reforms within taxation systems themselves, these fiscal constraints could arguably be reduced by:

• accelerating the market-oriented development of internationally competitive industry clusters by methods like those suggested in Beyond Competition Policy (2015). Such methods have the potential to: (a) accelerate the emergence of market-understanding of the relevant components of potential industry clusters; (b) encourage complementary initiatives to establish those capabilities; (c) provide opportunities for profitable investment that are less obsessively-focused on over-priced real estate; and (d) boost economic competitiveness / productivity – and thus strengthen Australia’s tax base and the revenues that governments gain from any given tax arrangements;
• ensuring that states (who carry to primary responsibility for encouraging economic development) have financial incentives to take the development of a modern high-value added economy seriously. They arguably do not do so under current tax regimes in which their revenues are based more on economic turnover than on economic value added (see Economic development incentives, 2009);
• emphasise governments’ primary function (ie ‘governing – which implies the creation of an environment in which others can ‘do things’) rather than their secondary function of ‘doing things’ themselves (eg providing public goods and services). Reasons that this should be helpful were outlined in a Queensland context in Making Government Effective (2013);
• recognition of the potential for governments to be unable to compensate for inequalities, provide for the disadvantaged and meet social needs to past standards (see The Probable Need for a Community-Based Solution). As the latter suggests efforts to promote increased self and mutual help within the community arguably could to be encouraged as an alternative.

John Craig

Eliminating Excessive Superannuation Tax Concessions Without an Administrative Nightmare - email sent 23/4/15

Hon Mr Bill Shorten, MP
Leader of the Federal Opposition and

Hon Mr Chris Bowen, MP
Shadow Treasurer

Re: Maher S., and Owens J., ‘ALP eyes super tax hit for wealthy’, The Australian, 22/4/15

Your reported proposal to tax superannuation earnings above $75,000 pa for those with account balances in excess of $1.5m would seem to create severe administrative difficulties and costs – because of the fact that individuals will tend to have superannuation accounts with multiple institutions.

Determining any individual’s tax liabilities within any given fund will require a central authority to assemble reports from all funds to identify which individuals are liable to pay this tax and then provide this information to the various fund managers who need to make tax deductions. This annual process could well take months / years to complete – during which time it would be impossible for fund managers to finalize their overall accounts or provide statements to their members.

An alternative method to reduce (in fact eliminate) excessive superannuation tax concessions was submitted in 2013 in Overcoming excess costs of superannuation system - a 'new RBL' suggestion. Defining a truly ‘reasonable’ (and in fact generous) benefit limit beyond which funds would need to be withdrawn from the superannuation system (with some inconvenience and the payment of avoided taxes) would:

• Have no effect on any but the most affluent;
• Discourage excessive superannuation contributions – and thus eliminate the need for complex contribution constraints;
• Eliminate the tax concessions that currently benefit affluent Australians whose superannuation balances exceed the ‘reasonable benefit limit’;
• Simplify the superannuation system – and reduce the administrative costs of seeking to reduce tax avoidance through that system.

John Craig

Making People Independent of the Government Age Pension - email sent 23/5/15

Michael Pascoe

Re: What the pollies won't do: apply principles to superannuation, Business Day, 22/5/15

Your article suggested (reasonably) in relation to superannuation tax concessions that:

"The tax system should support and encourage superannuation savings up to the point of making people independent of the government age pension."

A suggestion about how this might be achieved is in Overcoming excess costs of superannuation system - a 'new RBL' suggestion (2013). This involves determining a (genuinely) reasonable benefit limit (RBL) and requiring amounts above that limit to be withdrawn from the superannuation system. A rough estimate of what that amount might have been for a homeowner couple in 2013 was:

• $1.7m if the goal was to ensure that they did not receive any pension at all over a 30 year retirement; and
• $750,000 if it was accepted that the goal was not to have a fully ‘self-funded’ retirement but merely that they could afford to live a comfortable lifestyle for 30 years drawing upon their superannuation and a steadily increasing pension ‘top-up’ as their superannuation asset declined ultimately to zero

To achieve what you suggested (ie making people independent of the government age pension) would probably require setting a ‘new RBL’ at about $1.7m.

Regards

John Craig

Budget Repair - email sent 13/3/16

Gene Tunny
Queensland Economy Watch

Re: Why is Budget Repair So Difficult, Queensland Economy Watch, 13/3/16

Budget repair is not simple because it is not just a matter of domestic policy.

The massive differences between Western and East Asian economic and financial systems have had a critical effect – though one that has simply not been understood because of intellectual foundations of such systems are so dramatically different to Western traditions (see East Asia: The Realm of the Autocratic, Hierarchical and Intuitive Ethnic Group?, 2001, and Understanding East Asia's Neo-Confucian Systems of Socio-political-economy , 2009). The background to my work in this area (which Chalmers Johnson) a US guru on Japan’s economic ‘miracles’ described as ‘being on the leading edge of the social sciences is outlined here. The net effect of the savings gluts / demand deficits that were needed to avoid financial crises (ie by building-up large foreign exchange reserves) in major East Asian systems where profitability was not the criteria for resource allocation (as emphasis is rather always placed on accelerated development of ‘real economy’ capabilities) was to make global growth unsustainable unless their trading partners were willing and able to tolerate constantly rising debt levels by adopting easy money policies (see Impacting the Global Economy, 2009).

The effect in Western economies of reliance on easy money policies was to boost asset values, but do little to build up the ‘real economy’, increase social inequality (because only the already affluent were benefitting) and ultimately create the foundation of political instability which is currently revealed in in the Trump phenomenon in US. The potential for an alienated electorate which does not really understand its economic problem or opportunities to bring an end to the post WWII ‘liberal’ international order and thus allow the authoritarian systems to capture global control is increasingly real (see also Should Donald Duck?). What is happening can perhaps be equated with the emergence of widespread social disadvantage and political instability associated with Hanson phenomenon in Australia in the 1990s. This arose because of the inadequacies of market liberalization in boosting ‘real economy’ capabilities. Market liberalization boosted the requirement to compete but not the competitive advantages needed to do so successfully in high value added activities. Engaging in a deliberate apolitical process of accelerating market driven economic learning / competitiveness / productivity (ie setting up a process to allow Australia to have an economic ‘miracle’ also) would have produced a better outcome. Australia was lucky at that time because Hansonist ignorance only captured partial, not top level, political control – and the democratic process was able to force recognition of that ignorance and stifle it.

Some thought in this context about Australia’s looming budgetary problems and what might be done about them were outlined in 2009. This basically pointed to the need to create a real financial incentive for states (who have main responsibility in this area) to take economic development seriously eg through facilitating a deliberate apolitical process of accelerating economic learning.

You recently pointed to the fact that NFPs are running into problems because of an inability to rely on public funding. The suggestion that I recently drew attention to on how this might best be addressed should have been labeled The Probable Need for a Community-Based Solution.

John Craig

Complexities in Estimating the Cost of Tax Breaks for Seniors - email sent 21/11/16

John Daley, Brendan Coates and William Young
Grattan Institute

RE: Why special tax breaks for seniors should go, Online Opinion, 20/11/16

The calculations of savings in your article do not seem to include the effect of tax concessions on potential retiree’s savings’ strategies and thus on the federal government’s aged pension costs. As I understand it, tax concessions on superannuation were introduced originally to encourage savings through superannuation to reduce dependence on age pensions.

I produced a computer model some years ago which calculated the maximum rate of spending that a retired couple could sustain for their expected lifetimes with a given amount of initial capital on retirement. This took account of earnings on their assets, the effect of tax concessions and their entitlement to increased pensions as their own assets were depleted. This showed a couple’s ‘sustainable lifetime spending’ increased until their initial assessable retirement assets reached (about) $200,000 and then were stable until their assessable retirement assets reached (about) $600,000. Only above $600,000 did their ‘sustainable lifetime spending’ again started increasing. This implied that couples with little prospect of accumulating more than $600,000 were better off not having more than $200,000 in assessable assets and (a) investing in non-assessable assets such as their homes; and (b) relying almost entirely on pensions. Though I suspect that few then understood the issue, encouraging some potential retirees to invest primarily in real estate had the potential to contribute to increasing housing affordability problems.

Recently the federal government reduced the tax concessions for seniors (ie increased the taper rate at which pensions fall as people’s net assets increase). On the basis of a much simpler analysis, various observers have now highlighted the fact that .. retirees would be no better off if they have $1m in assessable assets than if they have only $200,000. Financial advisers will now be advising potential retirees of the limited benefits for most people of saving for retirement through assessable assets that would reduce government pension costs. This will presumable further exacerbate the housing affordability problem.

It seems to me that any calculations of the effect of tax breaks for seniors need to consider the effects on people’s incentives to save for retirement and thus on the federal government’s pension costs. The effect on housing affordability of encouraging some older Australians to hold mainly non-assessable assets (eg as the homes they live in) also needs consideration.

John Craig

Note added later: There was a a dramatic (20%) fall in net superannuation contributions over the year to September 2016. The industry had been expecting a net drawdown to not start until 2030. It has been brought forward because many people are taking a lot of money out of the system [1]. Uncertainty about future changes to superannuation rules were suggested in this article to be a factor in these withdrawals.

Implications of Asset Test Changes to Pensions - email sent 2/1/17

Madonna King

Re: The Turnbull government's assault on pensioners is a red alert for us all, Brisbane Times, 28/12/16

Another point that could be made at some time relates to the likely effect of superannuation changes on retirees’ investment strategies and the possible impact on the budget and housing affordability.

Until recently, the rate at which pensions were reduced used to be $1.5 per fortnight / $1000 of additional assets (ie 3.9% pa of additional assets).

Now it has doubled to $3 / $1000 per fortnight (ie 7.8% pa of additional assets). This will provide many pensioners with a huge incentive to withdraw funds from superannuation to upgrade in their homes – whose values are not counted in the asset test. Not only is it hard, verging on impossible in a low interest rate environment, to get a reliable return of 7.8% pa on investments, the return needed to justify leaving assets in superannuation where the total is in the critical range must now exceed 7.8% pa plus the tax free capital gain (less costs) of investing in real estate.

There have been a number of hints (eg the fact that large amounts seemed to be being withdrawn quite unexpectedly from superannuation in the year to September 2016) that financial advisers have worked this out – and are advising clients who have assets in the critical range to get some / a lot of money out of superannuation. The net effect could well be a large increase in the cost to government of pensions, and (perhaps) a worsening of the problem of housing affordability.

John Craig