The HIA says that stamp duty bills have increased almost three times faster than house prices since the 1980s and this trend will continue unless stamp duty is reformed. This result is contained in the latest edition of the HIA’s Stamp Duty Watch report which provides an analysis of state governments increasing reliance housing taxes.
The results also highlight just how much high property prices are helping to stoke state coffers – $20.6 billion in 2016- and the risks attached should this change! A switch to a broader property or land tax might be an option, but is politically risky. This would need to be part of broader property sector reform.
HIA Senior Economist, Shane Garrett says
In Victoria, the typical stamp duty bill increased from 1.9 per cent to 5.2 per cent of the median dwelling price between 1982 and 2017 – equivalent to a surge of 4,000 per cent in the cash value of stamp duty. NSW homebuyers fared little better with the stamp duty burden rising from 1.6 per cent to 3.8 per cent over the same period.
Increases in home prices cause stamp duty bills to accelerate because stamp duty rate brackets are rarely updated. This is the problem of stamp duty creep.
In NSW, stamp duty rates have not been reformed since the average house price was $70,000 (1985).
State governments are compounding the housing affordability crisis. Total stamp duty revenues have almost doubled over the past four years: from $11.7 billion in 2011/12 to $20.6 billion in 2015/16 – most of which is likely to have come from residential building. State governments are now more reliant on stamp duty revenues than at any time for a decade. This trend will continue unless state governments recalibrate their taxes on housing.
State governments are increasingly reliant on rising stamp duty revenues. This situation is not sustainable.
The stamp duty burden is increasing under every metric: nominal dollars, real dollars, as a proportion of dwelling prices and as a share of total state revenue. Without reform, this trend will continue.
By draining the pockets of homebuyers to the tune of over $20 billion each year, stamp duty is a central pillar of the affordability crisis. A long plan to do away with the scourge of stamp duty would be a huge victory for housing affordability in this country.
More evidence that negative gearing should be revised was contained in a preliminary paper released recently, having been discussed with the RBA in November. Melbourne University researchers Yunho Cho, Shuyun May Li, and Lawrence Uren suggest their modelling shows that the removal of negative gearing would potentially lift homeownership rates by 5.5%, and that “renters and owner-occupiers are winners, but landlords, especially young with high earning landlords, lose”. They stress this is preliminary, but nevertheless it adds to the weight of evidence that negative gearing should be reformed. Their data also again shows how a small number of affluent landlords are benefiting disproportionately at the expense of the tax payer .
The welfare analysis suggests that eliminating negative gearing would lead to an overall welfare gain of 1.5 percent for the Australian economy in which 76 percent of households become better off.
This is significant, given the annual government expenditure
on negative gearing is estimated to be $2 billion, or 5 percent of the budget deficit for the year 2016. Eliminating negative gearing would reduce housing investments and house prices, and increase the average home ownership rate. The supply of rental properties falls, rents increase but only marginally because its demand also falls.
The data in their report also underlines the significant growth in property investors, and the consequential rise in mortgage lending and negative gearing.
The left panel in Figure 1 shows that the proportion of landlords has risen by around 50 percent over the last two decades. The right panel in Figure 1 shows that the real housing loan approvals have also increased dramatically during the same period. In particular, the loan approvals for investment purposes increased more sharply than that for owner-occupied purposes, surpassing it by around $0.5 billion in the early 2010s.
Figure 2 documents the proportion negatively geared landlords and the aggregate net rental income across the period from 1994 to 2015. The left panel in Figure 2 shows that the proportion of negatively geared landlords has increased from 50 percent in 1994 to around 60 percent in 2015. The right panel in Figure 2 shows that the aggregate net rental income became large negative from the early 2000s onwards. Evidence shown in Figures 1 and 2 suggest that Australian households increasingly participate in the residential property investment and take advantage of negative gearing, reducing tax obligations with the flow loss incurred from their housing investment.
Figure 3 compares the share of households with home loans for investment by age (left panel) and income percentile (right panel) for the years 2002 and 2014. There has been a significant increase in the share, particularly among young to middle-aged households.
The largest increase was occurred in the age group 25 – 35, increased by 85 percent from 7 percent to 13 percent. From the right panel, we find that the share of households with investment housing loans has increased mainly among those in upper income percentiles.
These evidence are in line with the arguments by opponents of negative gearing that the policy essentially benefits the rich households who borrow and speculate in the property market. The fact that the distribution of housing investment loans is different across age and income also motivates our use of a heterogeneous agents incomplete markets model to study the implications of negative gearing.
Finally, of course is the important point, should interest rates rise then the value of negative gearing claimed will rise, putting a heavier burden on the Treasury, at a time when the cost of Government borrowing would be also rising. A double whammy – a multiplier effect.
Labor MPs might be rubbing their hands together with glee at a Treasury memo that shows the federal opposition’s negative gearing policy will have a “small” impact on the property market. But insights from behavioural public policy, as highlighted by the 2017 Economics Nobel laureate – Richard Thaler and his colleague Cass Sunstein, tell us that how people respond to this policy will be more about how the government frames it.
The Treasury memo showed the Labor policy of limiting negative gearing to existing homeowners will have a limited impact as the changes are unlikely to encourage investors to sell quickly. Also, owner-occupiers dominate the housing market and the costs of selling are high.
However, this assumes that people are forward-looking, well-informed, good with numbers and perfectly responsive to new information. Behavioural economics shows us that people do not always think so deeply and logically about their choices.
How any changes to negative gearing are sold to us – as a loss or gain, as a one-off or ongoing, in terms of short versus long term costs and benefits – will impact how Australians react.
Most of us aren’t whizzes with mathematics. As Nobel prize winner Herbert Simon has shown, in place of complex mathematical algorithms we use heuristics. These are simple rules of thumb that draw on our intuitions, experience and gut feel.
Heuristics and biases
One common example of a heuristic is the availability heuristic. This is when we make decisions based on easily available information such as recent events and highly emotive experiences. Our brains work better with narratives and stories than with facts and figures.
Nobel economics laureates George Akerlof and Robert Shiller have applied a similar insight to analyse people’s perceptions of housing market fluctuations. They noted that we hear lots of stories about how house prices are on an upward trend. Via the availability heuristic, we easily remember these emotionally engaging stories, much better than we can remember the dry facts about the history of house price instability and housing market crashes.
This leads us to overestimate the chances of continuing house price rises, and to underestimate the chances of a fall, driving unsustainable house price increases – as witnessed, for example, in the American sub-prime property markets before the global financial crisis.
While heuristics can help us to decide quickly, they sometimes lead us into systematic mistakes – “behavioural biases”. This does not mean that we’re all hopelessly irrational. But for negative gearing it matters how a potential change is framed, and how that fits into our heuristics and biases.
Most economists (including those at Treasury) assume that one dollar is a perfect substitute for any other dollar. Whether we save A$100 via a tax break, win A$100 from a scratch card or earn A$100 from working overtime, it makes no difference.
Contrary to this view, behavioural economics has shown that the way we treat money is different depending on the contexts in which we earn and spend it. We have different “mental accounts” for consumption, wealth, regular income and windfalls. We are more likely to splurge money we’ve won from a scratch card than money we’ve earnt doing overtime.
This is another reason why framing is important. How the government frames a negative gearing change will determine the mental account to which we assign it, and therefore how we respond.
If negative gearing changes are considered a one-off hit – the opposite of a scratch card windfall – then property owners won’t worry so much. On the other hand, if the change to negative gearing is seen as an ongoing drain on our incomes, then they will worry a lot.
Another factor that will come into play is loss aversion – people are much more likely to worry about losses than gains. Evidence from behavioural experiments shows that home-owners over-estimate the value of their properties. This makes them reluctant to sell at reduced prices in a falling market.
It also means that Australians will resist negative gearing changes if these are framed as a loss, creating political pressures for a policy u-turn. It is difficult to predict how people might respond, but behavioural economics shows that any ructions might be avoided if the negative gearing change is framed as a gain.
For instance, Treasury predicts that the additional revenue raised from restricting negative gearing could be up to A$3.9 billion. Therefore, the negative gearing changes could cover more than 80% of federal government expenditure on veterans and their families.
In the long and short term
Treasury’s modelling notes there might be downward pressure on house prices in the short term from changing negative gearing, but that this will be small overall.
But a range of models and experiments have shown that people are disproportionately focused on tangible, short-term outcomes. For example, most of us find it hard to persuade ourselves to go the gym: the short-term costs are inconvenience and discomfort and the benefits seem intangible and distant. This is called “present bias”.
Recent work in behavioural economics confirms that framing (alongside a range of other socio-psychological influences) has a strong impact on our choices. Framing will determine how we perceive the policy, which mental account we will use to process it and how the various heuristics and biases identified by economics and psychologists will play out.
In the debates around negative gearing policy changes, these behavioural insights have not been highlighted. So perhaps Treasury could have added some psychology, alongside the economics, in arguing that house price falls are likely to be limited.
Author: Michelle Baddeley , Research Professor at the Institute for Choice, University of South Australia
NAB says that Australians who are looking to buy their first home or are preparing for retirement could be in for a windfall in 2018, with a number of key superannuation changes expected to come into effect.
NAB Director of SMSF and Customer Behaviour, Gemma Dale said a number of key super reforms are expected to come into effect this year, so it’s important consumers stay on top of these change to ensure they capitalise on the opportunities.
“One of the big changes this year is the Downsizer contribution, which allows individuals aged 65 years plus to make non-concessional contributions of up to $300,000 per person to their super from the proceeds of selling their main residences,” Ms Dale said.
“But it is important to note that these contributions only apply to contracts of sale entered into from 1 July 2018, and the property also needs to be owned for at least 10 years before disposal.’’
Another key change is the first home super saver scheme.
“This scheme will allow eligible individuals who make voluntary super contributions from 1 July 2017 to withdraw these contributions, together with associated earnings for the purpose of purchasing their first home,” Ms Dale said.
“These voluntary contributions will be limited to $15,000 per year, up to a total of $30,000, and count towards the relevant contribution cap.
“Eligible individuals will be able to have up to 100 per cent of non-concessional and 85 per cent of concessional contributions plus associated earnings withdrawn from super to purchase their first home from 1 July.
“However, it is important to note, that the legislation for this scheme is yet to be passed, so there is a risk any voluntary contributions made in anticipation of it could be locked into individuals’ super.”
From 1 July, individuals with super balances of less than $500,000 on 30 June of the prior financial year will be able to access a higher annual cap and contribute their remaining unused concessional contribution cap on a rolling basis for a period of five years. But only unused amounts accrued from 1 July 2018 can be carried forward.
“This measure will enable customers who take time out of work or work part-time to make catch-up contributions when they accumulate lumpy income or decide to work full-time,’’ Ms Dale said.
Ms Dale encouraged Australians to seek advice before making any decisions to ensure it is in their best interest.
Some key super changes expected to come into effect from 1 July 2018
First home super saver scheme – This scheme allows eligible individuals who make voluntary super contributions on or after 1 July 2017 to withdraw these contributions, together with associated earnings for the purpose of purchasing their first home. These voluntary contributions are limited to $15,000 per year, up to a total of $30,000 and count towards the relevant contribution cap.
Downsizer contributions – The Government introduced a Bill in September 2017 allowing individuals aged 65 years or over to make non-concessional contributions of up to $300,000 (per person) to their superannuation from proceeds of selling their main residences
Catch-up contribution concessions – Individuals with super balances less than $500,000 on 30 June of the prior financial year will be able to access a higher annual cap and contribute their remaining unused concessional contribution cap on a rolling basis for a period of five years. Only unused amounts accrued from 1 July 2018 can be carried forward.
The U.S. middle class has always had a special mystique.
It is the heart of the American dream. A decent income and home, doing better than one’s parents, and retiring in comfort are all hallmarks of a middle-class lifestyle.
Contrary to what some may think, however, the U.S. has not always had a large middle class. Only after World War II was being middle class the national norm. Then, starting in the 1980s, it began to decline.
President Donald Trump has portrayed the tax plan Congress is wrapping up as a boon for the middle class. The sad reality, however, is that it is more likely to be its final death knell.
To understand why, you need look no further than the history of the rise and decline of the American middle class, a group that I’ve been studying through the lens of inequality for decades.
The middle class rises
The middle class, which Pew defines as two-thirds to two times the national median income for a given household size, began to grow after World War II due to a surge in economic growth and because President Franklin Delano Roosevelt’s New Deal gave workers more power. Before that, most Americans were poor or nearly so.
For example, legislation such as the Wagner Act established rights for workers, most critically for collective bargaining. The government also began new programs, such as Social Security and unemployment insurance, that helped older Americans avoid dying in poverty and supported families with children through tough times. The Home Owners’ Loan Corporation, set up in 1933, helped middle-class homeowners pay their mortgages and remain in their homes.
Together, these new policies helped fuel a strong postwar economic boom and ensured the gains were shared by a broad cross-section of society. This greatly expanded the U.S. middle class, which reached a peak of nearly 60 percent of the population in the late ‘70s. Americans’ increased optimism about their economic future prompted businesses to invest more, creating a virtuous cycle of growth.
Despite high taxes on the rich and on corporations, median family income (after accounting for inflation) more than doubled in the three decades after World War II, rising from $27,255 in 1945 to nearly $60,000 in the late 1970s.
The fall begins
That’s when things started to change.
Rather than supporting workers – and balancing the interests of large corporations and the interests of average Americans – the federal government began taking the side of business over workers by lowering taxes on corporations and the rich, reducing regulations and allowing firms to grow through mergers and acquisitions.
Since the late 1980s, median household incomes (different from family incomes because members of a household live together but do not need to be related to each other) have increased very little – from $54,000 to $59,039 in 2016 – while inequality has risen sharply. As a result, the size of the middle class has shrunk significantly to 50 percent from nearly 60 percent.
In addition, Reagan cut taxes multiple times during his time in office, which led to less spending to support and sustain the poor and middle class, while deregulation allowed businesses to cut their wage costs at the expense of workers. This change is one reason workers have received only a small fraction of their greater productivity in the form of higher wages since the 1980s.
In contrast, household median income in 2016 was only slightly above its level just before the Great Repression began in 2008. But according to new unpublished research I conducted with Monmouth University economist Robert Scott, the actual living standard for the median household fell as much as 7 percent due to greater interest payments on past debt and the fact that households are larger, so the same income does not go as far.
As a result, the middle class is actually closer to 45 percent of U.S. households. This is in stark contrast to other developed countries such as France and Norway, where the middle class approaches nearly 70 percent of households and has held steady over several decades.
The Republican tax plan
So how will the tax plan change the picture?
France, Norway and other European countries have maintained policies, such as progressive taxes and generous government spending programs, that help the middle class. The Republican tax package doubles down on the policies that have caused its decline in the U.S.
Specifically, the plan will significantly reduce taxes on the wealthy and large companies, which will have to be paid for with large spending cuts in everything from children’s health and education to unemployment insurance and Social Security. Tax cuts will require the government to borrow more money, which will push up interest rates and require middle-income households to pay more in interest on their credit cards or to buy a car or home.
The benefits of the Republican tax bill go primarily to the very wealthy, who will get 83 percent of the gains by 2027, according to the Tax Policy Center, a nonpartisan think tank.
Meanwhile, more than half of poor and middle-income households will see their taxes rise over the next 10 years; the rest will receive only a small fraction of the total tax benefits.
From virtuous to vicious
While Republicans justify their tax plan by claiming corporations will invest more and hire more workers, thereby raising wages, companies have already indicated that they will mainly use their savings to buy back stock and pay more dividends, benefiting the wealthy owners of corporate stock.
So with most of the gains of the $1.5 trillion in net tax cuts going to the rich, the end result, in my view, is that most Americans will face falling living standards as government spending goes down, borrowing costs go up, and their tax bill rises.
This will lead to less economic growth and a declining middle class. And unlike the virtuous circle the U.S. experienced in the ‘50s and ’60s, Americans can expect a vicious cycle of decline instead.
Author: Steven Pressman, Professor of Economics, Colorado State University
Such reform would deliver a modest and temporary spur to growth, already reflected in growth forecasts of 2.5% for 2018. However, it will lead to wider fiscal deficits and add significantly to US government debt. As such, Fitch has revised up its medium-term debt forecast.
US federal debt was 77% of GDP for this fiscal year. Fitch believes the tax package will be revenue negative, even under generous assumptions about its growth impact. Under a realistic scenario of tax cuts and macro conditions, the federal deficit will reach 4% of GDP by next year, and the US debt/GDP ratio would rise to 120% of GDP by 2027.
The Republican tax plan delivers a tax cut on corporations, seeking to lower the corporate tax rate to 20% from 35%, and removing many exemptions, while eliminating some tax breaks affecting corporate and personal filers. It would leave the overall personal tax burden somewhat lower, although the effects would differ depending on circumstances.
Tax cuts may lead to a short-lived boost to output, but Fitch believes that they will not pay for themselves or lead to a permanently higher growth rate. The cost of capital is already low and corporate profits are elevated. In addition, the effective tax rate paid by large corporations is well below the existing statutory rate. From a macroeconomic perspective, adding to demand at this point in the economic cycle could add to inflationary pressures and lead to additional monetary policy tightening.
Fitch expects US economic growth to peak at 2.5% in 2018 before falling back to 2.2% in 2019. The US will enter the next downturn with a general government “structural deficit” (subtracting the impact of the economic cycle) larger than any other ‘AAA’ sovereign, leaving the US more exposed to a downturn than other similarly rated sovereigns.
The US is the most indebted ‘AAA’ country and it is running the loosest fiscal stance. Long-term debt dynamics are also more negative than those of peers, with health and social security spending commitments set to rise over the next decade. In Fitch’s view, these weaknesses are outweighed by financing flexibility and the US dollar’s reserve currency status, underpinning its ‘AAA’/Stable rating. The main short-term risk to the rating would be a failure to raise the debt ceiling by 1Q18, when the Treasury’s scope for extraordinary measures is expected to be exhausted. The debt ceiling is currently suspended until early December.
The paper says that the economic impact of the Republicans’ tax plan will depend on how time and compromise shape the package that is ultimately legislated. Key in this regard is the size of the cut, how it is funded and whether investors believe it is a permanent reduction.
On 27 September 2017, the United States (US) Administration and Republican Congressional leadership released a framework for US tax reform, including a reduction in the federal corporate tax rate from 35 to 20 per cent.
The key elements of tax framework with respect to corporate tax are:
a reduction in the federal corporate income tax rate from 35 to 20 per cent;
immediate expensing of depreciable assets (except structures) for at least 5 years;
limitations on interest deductions;
the removal of the domestic production deduction;
an exemption for dividends paid by foreign subsidies to US companies (where the US company owns 10 per cent or more of the foreign company); and
a one-time tax on overseas profits.
These proposals were reflected in the draft of the Tax Cuts and Jobs Act released by the House Ways and Means Committee on 2 November 2017.
This paper examines the likely impact of this reform on the US and rest of the world, placing the US changes in the context of the global trend toward lower corporate taxes.
In theory, a corporate tax rate cut stimulates investment by making more investment opportunities sufficiently profitable to attract financing. The extent to which this is the case in practice will depend on how the tax cut is funded and whether investors consider the tax cut to be permanent. If the corporate tax rate cut results in an overall reduction in tax on US investments and investors believe that the tax cut is permanent, we are likely to see an increase in the level of US investment. If investors believe that the tax cut is temporary, the effect on US investment may be minimal. Ultimately, the economic impact of the plan on the US will depend on how time and compromise shape the final package.
If a US corporate tax cut does result in an investment boom, goods, labour and funds will be required. In a scenario in which the investment boom is largely funded domestically from US savings, negative impacts on the rest of the world are likely to be short-lived and modest.
Realistically, however, a US investment boom is likely to be only partially funded domestically and would draw funds and goods from the rest of the world. In this scenario, the rest of the world would experience a decline in capital stock resulting from the flow of capital into the US. The magnitude of the resulting welfare loss in those countries will depend on the size of the US corporate tax cut; how it is funded; the elasticity of the US labour supply response and the US saving response. For Australia, the size of the negative impact will also depend on how other countries respond.
While the size of the US economy means changes to the US tax system have particular significance, it is important to consider these reforms as part of an ongoing trend. As capital markets have become increasingly global and business location increasingly mobile, governments have sought to drive economic growth in their jurisdictions by lowering corporate tax rates. The US reforms have the potential to accelerate tax competition between jurisdictions, making Australia’s current corporate tax rate increasingly uncompetitive internationally.
While the Administration and Republican Congressional leadership have indicated that they will ‘set aside’ the idea contained in the House Republicans’ 2016 plan to move to a destination-based cash flow tax (DBCFT), this paper also provides a discussion of the theoretical underpinnings of the proposal.
Usually, however, politicians and policymakers have favored one type of stimulus over the other. Conservatives like tax cuts, while liberals favor more spending.
In the Trump administration, tax cuts appear to have won the argument for now. Republicans unveiled the blueprint of a major tax overhaul, which White House officials predict will boost economic growth to more than 3 percent a year. In the meantime, infrastructure investment remains on the back-burner.
Did they make the right choice pushing for tax cuts before infrastructure spending? Are tax cuts more likely than new spending to prod companies to produce more, encourage more consumer spending and grow the economy at a faster rate?
Or put another way, which provides the biggest bang for the buck?
Spending versus tax cuts
British economist John Maynard Keynes was the first to suggest in the 1930s that an economy’s ills could be traced to the misalignment of what he called aggregate demand, which is made up of consumption, investment, government spending and net exports. So if there’s trouble in the economy, a government could try to move the needle by spending more (or less) money or by adjusting tax rates to spur consumers or businesses to buy more (or less) stuff.
For decades, from the 1940s through the 1970s, the U.S. mainly relied on manipulating government expenditures rather than tax cuts to goose the economy. Many politicians and academics interpreted Keynes to favor government spending as the best way to right the economic ship, but he also suggested tax policy could do the job of boosting demand.
In the past few decades, however, beginning with President Ronald Reagan and the advent of supply-side economics in the 1980s, governments have increasingly toyed with tax cuts to change aggregate demand in part because they are more likely to have an immediate effect on consumer and business expectations and incentives.
Lord John Maynard Keynes, center, represented the U.K. at the Bretton Woods Conference in 1944, which established the International Monetary Fund and post-war monetary system.AP Photo
The question of whether tax cuts or spending has a greater economic impact – as well as the inverse – remains a major subject of discussion among economists and policymakers. With the help of my graduate students in a finance class I taught for three decades, I have tried to help shine some light on the answer.
The following analysis grew out of a series of research projects assigned to them in the past several years. Putting them together produced some insight on the questions I raised at the outset.
To compare the effects on the economy of increases in regular government spending with those of tax cuts, we compiled data on gross domestic product, government expenditures and average tax rates for households divided into five different income groups, or quintiles, from 1968 to 2010. We did that because a tax cut for someone who’s rich will be different than one for someone who spends most of what she earns. While the former might invest the extra cash, the latter is more likely to spend it, immediately stimulating the economy.
We focused on the middle three income groups because incomes among the top 20 percent are too disparate and the tax rate for the bottom is close to zero, making them very hard to measure.
We then tried to determine how much each variable – spending and tax rates of each quintile – correlated to a change in GDP. Our findings showed that US$1 in tax cuts for individuals making $20,001 to $61,500 a year in 2010 dollars (the second and third quintiles) was correlated with an increase in GDP more than double that of a rise in spending by the same amount. A tax cut for those in the fourth quintile earning $61,501 to $100,029 didn’t have as great effect but still correlated with a boost in GDP 1.4 times that of new spending.
These results are consistent with those conducted by economists David and Christine Romer in their study on the economic impact of changes in taxation, which also found that tax cuts correlated with more growth than spending increases.
What it means
So do these results answer our original question and show that tax cuts are always better?
Not exactly, although these results should appeal most to those who champion tax cuts for the middle class. For too long, ideology has dominated this debate and obscured the real answer if the goal is stronger economic growth: an appropriate mix of the two, well-tailored tax cuts for middle-income earners and effective government spending.
In addition, our analysis represents a relatively simplified take on a complicated topic. The last word on how tax cuts affect economic growth has yet to be written.
The real advantage of tax cuts is that they’re quick – taxpayers immediately have more money in their paychecks and companies often begin investing before the cuts have taken effect – while the impact of infrastructure or other spending takes much longer, even years, to work its way through the economy. But they both have their place in good economic policy.
Very often those advocating significant tax cuts claim that the cuts will pay for themselves in terms of ultimate tax revenues. That, of course, is an empirical issue but it misses the point. No one ever claims that expenditure increases pay for themselves (in terms of future tax revenues). The relevant point is how much does each encourage economic growth.
Author: Dale O. Cloninger, Professor Emeritus, Economics & Finance, University of Houston-Clear Lake
Economists tend to agree on the importance of competition for a sound market economy. So, what’s the problem when it comes to governments competing to attract investors through the tax treatment they provide? The trouble is that by competing with one another and eroding each other’s revenues, countries end up having to rely on other—typically more distortive—sources of financing or reduce much-needed public spending, or both.
All this has serious implications for developing countries because they are especially reliant on the corporate income tax for revenues. The risk that tax competition will pressure them into tax policies that endanger this key revenue source is therefore particularly worrisome.
Keep up with the others
Many have argued that tax competition between governments can trim wasteful spending and lead to better governance; the ‘starve the beast’ argument. But the mobility of tax bases across national borders makes this benefit less clear, whether the base relates to labor income, commodity transactions, or most commonly, capital income.
More technically, countries tend, with good reason, to tax things that are not highly responsive to taxation. But international mobility means that activities are much more responsive to taxation from a national perspective than from a collective perspective. This is especially true of the activities and incomes of multinationals. Multinationals can manipulate transfer prices and use other avoidance devices to shift their profits from high tax countries to low, and they can choose in which country to invest. But they can’t shift their profits, or their real investments, to another planet. When countries compete for corporate tax base and/or real investments they do so at the expense of others—who are doing the same. By failing to exploit the lesser responsiveness of tax base and investment at the collective level than at the national level, countries thus risk mutual harm by eroding a source of revenue that may well have been more efficient than the alternatives available to them.
Headline corporate income tax rates have plummeted since 1980, by an average of almost 20 percent. This doubtless reflects a variety of effects at work—changing views on the growth impact of corporate taxation, for instance—but it is a telling sign of international tax competition at work, which closer empirical work tends to confirm.
And even though revenues have remained steady so far in developing countries and increased in advanced economies—perhaps because, for unrelated reasons, the share of capital in national income has increased—there is nothing to guarantee that this will continue. And some developments could make tax competition more intense: if the OECD-G20 ‘BEPS’ project reduces tax avoidance, for instance, competition through other means could increase.
Fiercely competitive; fiercely contentious
To better understand these issues and how they might be addressed, the IMF and World Bank recently gathered together a hundred or so tax experts and officials. Embert St. Juste, of the Ministry of Finance in St. Lucia, for instance, noted that the members of the Organisation of Eastern Caribbean States have been competing with increasing fervour over foreign direct investment and tourism. And the Finance Minister of the Republic of Serbia, Dušan Vujović, said that with greater globalization, all countries have been dragged, willingly or not, into the fray.
Kimberly Clausing, an economics professor at Reed College, presented new work suggesting that paper profits may be much more sensitive to tax rates than previously thought. She cited a recent paper that finds that for every percentage point drop in the average tax rate in a low-tax jurisdiction, profits reported there by foreign corporations of U.S. multinationals increase by between 3.5 and 7 percentage points. This remains contentious. Paul Ryan from the Irish Department of Finance suggested that the impact, particularly from more advanced economies to less, has been exaggerated. But tax competition is generally seen as a real threat to revenue, most notably for developing countries.
There is an answer: use international coordination to stop, or at least limit, the race. That, however, is much more easily said than done.
Partial solutions can help but are inherently limited. As Michael Devereux of the University of Oxford stressed, if only some countries coordinate, they can make themselves more vulnerable to competition from those outside the group. And even if all coordinate, they can remain vulnerable if they do not do so over all relevant aspects of the tax system. Nonetheless, partial approaches can help.
Some recent proposals would fundamentally change corporate tax systems. Gaetan Nicodeme from the European Commission explained its proposal for a Common Consolidated Corporate Tax Base. Under the first stage of this, businesses operating in more than one European Union country would consolidate their taxable profits across borders, so the profits in one country could be offset against losses in another. In a second stage, their profits within the EU would be allocated for tax purposes across member states by a formula reflecting the proportions of their assets, employment or other indicators of their activities in each. This, however would not eliminate tax competition, since governments would still have an incentive to use low tax rates to attract investment, workers or whatever else appears in the allocation formula.
An alternative system that has attracted considerable attention recently in the United States is the destination-based cash-flow tax under which taxes are levied based on where goods end up (destination), rather than where they were produced. If adopted universally, and well designed, this would ease pressures of tax competition. But if adopted unilaterally by one or a few countries, it would amplify profit shifting problems for others. This is because, intuitively, profits from sales elsewhere could then be taken tax-free in those countries, which would likely lead those without a destination-based cash-flow tax to compete more aggressively, or adopt one themselves.
Issues of international tax competition are not going away anytime soon, and that there is a lot at stake for developing countries. In the face of possible tectonic shifts in tax systems, such as a move to a destination-based corporate taxation, it has become even more important to understand the cross-border impact of national tax policies and how governments react to them. This remains an issue of debate and study, and both the IMF and the World Bank plan to continue this analysis, including at this week’s high-level event co-organized with the Ministry of Finance of Indonesia. As part of the Voyage to Indonesia leading up to the World Bank-IMF Annual Meetings in 2018, the discussions will focus on the challenges that tax competition poses for the members of the Association of Southeast Asian Nations.
The budget has hit the banks hard, with a $6bn charge on bank liabilities aimed at the five biggest banks, as well as a focus on competition and executive accountability.
$6bn over four years would equate to an annual amount of around 5% of current year earnings for the big five. We estimate that the net interest margin would need to be lifted by 6 basis points to cover the costs. If this was applied to just the residential mortgage book rates would have to be lifted by around 15 basis points to achieve neutrality.
The key question will how these extra costs are recovered from the banking system. On past performance, they will simply reprice products to their consumer and small business customers.
New levy on the major banks
Consistent with its response to the Financial System Inquiry, the Government and the Australian Prudential Regulation Authority (APRA) remain committed to a range of reforms, including: setting bank capital levels such that they are ‘unquestionably strong’; strengthening APRA’s crisis management powers; and ensuring our banks have appropriate loss-absorbing capacity.
Complementing these reforms, the Government will introduce a levy on major banks with liabilities greater than $100 billion, raising $6.2 billion over four years. The levy will be used to support budget repair.
Ordinary bank deposits and other deposits protected by the Financial Claims Scheme – including those held by everyday Australians – will be excluded from the levy base. It will not be levied on mortgages.
The levy represents a fair additional contribution from our major banks. The levy will also provide a more level playing field for smaller, often regional, banks and non-bank competitors. Superannuation funds and insurance companies will not be subject to this levy.
The Government has also introduced legislation to recover the costs of financial conduct regulation by the Australian Securities and Investments Commission. It will also recover the costs of implementing a new framework for external dispute resolution. A one-stop shop for resolving financial disputes — the Australian Financial Complaints Authority — and a body for raising professional standards of financial advisers will be fully funded by industry.
A more accountable and competitive banking system
The Government will introduce a new dispute resolution framework that will empower bank, financial services and superannuation customers. The Government will also implement a package to increase accountability in the financial sector and make it more competitive. This will mean more choice, better services and greater protections for all Australians.
Improving accountability and competition
The financial services sector affects all Australians and is a backbone of the economy. For it to work effectively, Australians need to be confident that financial services providers will serve their interests. Too often banks and the sector have not met those expectations.
Building on the major financial sector reforms implemented last year, the Government is taking significant new action to ensure the sector meets the expectations of the Australian community.
The Government will create a new dispute resolution framework. There will be a new one-stop shop — the Australian Financial Complaints Authority (AFCA) — for external dispute resolution and greater transparency of internal dispute resolution by financial firms.
The Government will legislate a new Banking Executive Accountability Regime that will make senior bank executives more accountable and subject to additional oversight by the Australian Prudential Regulation Authority (APRA).
The Government will also introduce a number of reforms to boost competition and choice for Australian consumers in the financial system.
Improving dispute resolution
The Government will introduce major reforms to provide customers with access to fair dispute resolution in Australia by introducing a new one-stop shop.
A new one-stop shop will deal with all financial disputes, including superannuation, and provide access to free, fast and binding dispute resolution.
The new body AFCA will be able to hear disputes of a higher value so that more consumers and small businesses will have their disputes heard, and if they have wrongfully suffered a loss, access fair compensation.
Financial firms will be required to be members of AFCA, and its decisions will be binding on all firms.
AFCA will be governed by an independent board, with an independent chair and equal numbers of directors with industry and consumer backgrounds, and be wholly funded by industry.
AFCA will commence operations from 1 July 2018. The existing dispute resolution bodies will continue to operate after 1 July 2018 to work through their existing complaints.
Enhanced ASIC oversight
ASIC will be provided with stronger powers to oversee the new one-stop shop. ASIC will have a general directions power to ensure AFCA complies with legislative and regulatory requirements.
Internal dispute resolution
To increase accountability, the Government will also legislate to require financial firms to report to the Australian Securities and Investments Commission (ASIC) on internal dispute resolution outcomes.
Cameo: An improved dispute resolution framework
Sarah was a small business owner with a complaint with her bank over the interest charges on her $3 million loan. As the loan exceeded $2 million, Sarah was unable to access external dispute resolution and although Sarah was eventually successful in having her complaint resolved, she was forced to go through a lengthy and expensive court process.
Under the Government’s new framework, small business disputes related to loans of up to $5 million will be heard by the one-stop shop, which will be able to award compensation of up to $1 million. This will ensure more small businesses have access to free, fast and binding dispute resolution.
Banking Executive Accountability Regime
Registration of senior executives
Senior executives and directors of authorised deposit-taking institutions (ADIs), including all banks, will be required to be registered with APRA. The ADI will have to advise APRA prior to making a senior appointment.
This will mean APRA will have visibility of all ADI senior appointments prior to them being made.
Where senior executives have been found not to have met expectations they will no longer be able to be registered or employed in senior roles.
ADIs will be required to provide APRA with accountability maps of senior executives’ roles and responsibilities to enable greater scrutiny at the time of each person’s appointment and oversight of problems that emerge under their management.
Enhanced powers to remove and disqualify
APRA will be given stronger powers to remove and to disqualify senior executives and directors. These powers will apply to all institutions regulated by APRA.
Persons removed or disqualified under these powers would have to appeal to the Administrative Appeals Tribunal to have a decision reviewed.
Increased expectations and penalties
The new regime will establish expectations on how ADIs and their executives and directors conduct their business consistent with good prudential outcomes.
These expectations would cover matters such as conducting business with integrity, due skill, care and diligence and acting in a prudent manner.
A new civil penalty will be created with a maximum penalty of $200 million for larger ADIs, and a maximum penalty of $50 million for smaller ADIs, that fail to meet these new expectations, increasing incentives for ADIs to put in place processes to ensure they conduct their operations appropriately.
APRA will also be able to impose penalties on ADIs that do not appropriately monitor the suitability of their executives to hold senior positions.
The Government will mandate that a minimum of 40 per cent of an ADI executive’s variable remuneration – and 60 per cent for certain executives such as the CEO – be deferred for a minimum period of four years.
This will increase the financial consequences – by preventing bonuses being paid – for decisions which may take a long time to materialise. Executives will place greater focus on long-term outcomes than when there are shorter deferral periods.
APRA will also be given stronger powers to require ADIs to review and adjust their remuneration policies when APRA believes such policies are not appropriate.
The Government will provide $4.2 million over four years to APRA to implement these new measures.
The Government will also provide APRA with $1 million per annum for a fund to ensure it has the necessary resources to enforce breaches of the new civil penalty provisions.
Competition in the financial sector
The Government will increase consumer choice and improve competition in banking by giving customers access to and control over their banking data by introducing an open banking regime in Australia.
Increased access to data will improve the information available to consumers and better enable innovative business models to create new products tailored to individuals.
The Government will commission an independent review to recommend the best approach to implement the open banking regime to report by the end of 2017.
The Government has tasked the Productivity Commission to commence a review on 1 July 2017 of the state of competition in the financial system.
The Commission is to review competition with a view to improving consumer outcomes, the productivity and international competitiveness of the financial system and economy more broadly, and supporting ongoing financial system innovation, while balancing financial stability objectives. The Productivity Commission will have 12 months to report to Government.
This also delivers on a Government commitment in response to the Financial System inquiry for such a review.
Regular ACCC inquiries
Building on the Commission’s broad review of competition in the financial system, the Government will provide $13.2 million over four years to the Australian Competition and Consumer Commission (ACCC) to establish a dedicated unit to undertake regular inquiries into specific financial system competition issues.
It will facilitate greater and more consistent scrutiny of competition matters in the economy’s largest sector, which has been lacking to date.
This implements a recommendation of the House of Representatives Standing Committee on Economics report Review of the Four Major Banks.