Social Trends – Page 164 – Digital Finance Analytics (DFA) Blog

Why the Small Business Tax Break Could Pay for Itself

The immediate tax deduction for small business announced in the Federal Budget has been broadly welcomed, but what may have been missed is the fact that what the Government doesn’t collect now, it will collect later, according to The Conversation.

As part of the $5.5 billion small business package at the centre of its latest Budget, the Federal Government announced it would allow businesses with turnover less than $2 million to immediately deduct the cost of any individual asset purchased up to the value of $20,000, from Budget night through to the end of June 2017. The estimated cost of this accelerated depreciation measure to revenue is estimated at $1.75 billion over the four years of forward estimates.

But what should be noted about this measure is that it doesn’t change the eligibility for tax deductions of these assets; it simply changes how quickly a small business is able to receive the tax deduction.

Under the existing simplified depreciation rules for small business, an asset costing over $1000 would be depreciated at 15% for the first year, and 30% thereafter, until the taxable value of the asset pool is $1000 or less, at which point the full amount can be written off.

For a $20,000 asset, this would mean a $3,000 deduction would be allowable in the first year, and it would take around 10 years to fully depreciate it for tax purposes. This compares to a $20,000 deduction in the first year under the proposed measure.

Bear in mind, too, that small businesses fall into two general categories: those that are incorporated (companies), and those that aren’t (sole traders and partnerships). The taxable profits of small companies are taxed at a flat rate, which – assuming the announced 1.5% tax cut passes – will be 28.5%.

Unincorporated small businesses don’t get the 1.5% tax cut, as their income is included in the assessable income of the owners and taxed at their marginal rate of tax. Instead they’ll get a tax discount of 5% of business income up to $1000 a year.

Here, we’ll focus on small companies, where the flat rate of tax makes analysis easier.

For a small, incorporated business, and assuming the 28.5% tax rate, its tax bill would be reduced by $5,700 in the first year, as compared to only $855 under the existing regime. This is a total upfront benefit of $4,845, and supports the government’s argument that the change will improve cash flow for small business as compared to existing arrangements.

But the timing aspect also has a benefit for the Government, and there is evidence of this in the Budget Papers. Over the first three years of the forward estimates, the expected cost to revenue totals $1.9 billion. However, in the final year of the forward estimates (2018-19), this cost begins to reverse, and the Government expects to bring in an extra $150 million in revenue.

The reason for this reversal can be explained with respect to a hypothetical $20,000 asset purchased on July 1, 2015, by a small incorporated entity. Under the proposed rules, the company would have reduced its tax payable by $5,700 in the first year, as compared to only $855 under the existing rules.

This means the Government would collect $4,845 less tax from this company in respect of the 2015-16 tax year. However from the 2016-17 tax year onwards the Government will collect more, under the proposed measure, as this company has no further depreciation tax deductions available to it in respect to that asset.

This means that while over the forward estimates period, allowing this company to immediately deduct the cost of the asset in 2015-16 will cost the Government $1,662, it will subsequently collect $1,662 more in tax in the period beyond the forward estimates.

Mechanically, the total deduction for the asset under either the original simplified depreciation rules for small business or the proposed immediate write-off, will still be $20,000. In other words, whatever the Government doesn’t collect now it will collect later.

For the Government this is a good outcome politically for three reasons.

First, it allows it to say it is supporting small businesses to “have a go”, as Treasurer Joe Hockey puts it.

Second, even though there is a cost to revenue in the forward estimates period, over the following years this measure will have a positive impact on revenue. However, because this increase in revenue is primarily outside the forward estimates it is not visible in the Budget Papers.

This increase in revenue has to be equal to the cost – so the $1.75 billion net cost in the next four years will lead to an increase in revenue of $1.75 billion beyond the forward estimates.

Third, the Budget Papers contain only information on government decisions that involve changes since the previous Mid-Year Economic and Fiscal Outlook. So while this measure will mean the Government will collect more revenue over the years 2019-20 and onwards, this increase won’t register as a change in next year’s Budget and therefore this increase won’t be quantified there as such.

Payday Lending’s Online Revolution

Payday Lending has been subject to considerable regulation in recent years, but using data from our household survey’s and DFA’s economic modelling, today we look at expected trends, in the light of the rise on convenient online access to this form of funding.

We will focus on analysis of small amount loan – a loan of up to $2,000 that must be repaid between 16 days and 1 year. ‘Short term’ loans of $2,000 or less repayed in 15 days or less have been banned since 1 March 2013. These rules do not apply to loans offered by Authorised Deposit-taking Institutions (ADIs) such as banks, building societies and credit unions, or to continuing credit contracts such as credit cards. More detail are on ASIC’s Smart Money site.

The law requires credit providers to verify the financial situation of applicants, and to ask for evidence from documents like payslips or Centrelink statements, copies of bills, copies of other credit contracts or statements of accounts or property rental statements. The number of documents a lender asks for will depend on whether they have relationship data, credit history or bank statements. If households receive the majority (50% of more) of income from Centrelink, the repayments on the small amount loan (including any other small amount loans held) must not exceed 20% of income. If they do, potential applicants will not qualify for a small amount loan.

From 1 July 2013, the fees and charges on a small amount loan have been capped. While the exact fee will vary depending on the amount of money borrowed, credit providers are only allowed to charge a one-off establishment fee of 20% of the amount loaned, a monthly account keeping fee of 4% of the amount loaned, a government fee or charge,default fees or charges and enforcement expenses. Credit providers are not allowed to charge interest on the loan. This cap on fees does not apply to loans offered by ADIs such as banks, building societies or credit unions.

DFA covered payday lending in a recent post, and ASIC has been highlighting a range of regulatory and compliance issues.

So, we begin our analysis with an estimation of the size of the market, and the proportion of loans originated online. The value of small loans made has been rising, and we now estimate the market to be more than $1bn per annum. We expect this to rise, and in our forward modelling we expect the market to grow to close to $2bn by 2018 in the current economic and regulatory context.

One of the main drivers of this expected lift is the rise in the number of online players, and the rising penetration of online devices used by consumers. Today, we estimate from our surveys about 40% of loans are online originated. We estimate that by 2018, more than 85% of all small loans will be originated online. As we highlighted in our previous post, the concept of instant application, and fast settlement is very compelling for some households.

The DFA segmentation for payday households identifies two discrete segments. The first, which we call disadvantaged are households who are likely to be frequent users of small amount loans, often on Centrelink benefits, are socially disadvantaged, and with poor work history. The second segment is one which we call inconvenienced. These households are more likely to be in employment, but for various reasons are in a short term cash crisis. This may be because of unexpected bills, illness, unemployment, or some other external factor. They may even borrow for a holiday or family event such as wedding or funeral. They are less likely to be serial borrowers.

We see that both segments are tending to use online tools to seek a loan and may also be accessing other credit facilities. Our prediction is that by 2018, of the total of all small loans applied for, more than 35% will be applied for by disadvantaged, and 45% by inconvenienced via online. Together this means that as many as 90% of loans could be be sourced online. More than three quarters of these applications will be via a smart phone or tablet. As a result the average age of a small loan applicant is dropping, and we expect this to continue in coming years. This helps to explain the rise on TV and radio advertising, directing households with financial needs direct to a web site. Phone based origination, as a result is on the decline. We estimate there are more than 100 online credit providers in the market, comprising both local and international players. Online services means the credit providers are able to access the national market, whereas historically, many short terms loans were made locally by local providers, face to face. This is a significant and disruptive transformation.

We finally look at the segment splits in terms of number of households using these loans. We note a significant rise in the number of inconvenienced households, to the point where by 2018, about half will be this segment. This is because the rules have been tightened for disadvantaged households, and online penetration for inconvenienced is higher.

Rental Yields Fall – CoreLogic RP Data

According to analysis from CoreLogic RP Data, rental rates across the combined capital cities increased by 0.1% in April and continue to rise at their slowest annual pace in more than a decade. While rental rates tell part of the story, it is also important to consider rental yields. Rental yields for houses and units are sitting at their lowest level since late 2010. There is a reason for the disconnect between rising house prices and rents. That is simply because rents are more directly linked to average incomes than home values. As we reported recently, income growth is slowing.

Across the combined capital cities, gross rental yields are recorded at 3.6% for houses and 4.5% for units. At the same time in 2014, gross rental yields were recorded at 3.8% for houses and 4.6% for units. Across the individual capital cities, house rental yields are lowest in Melbourne (3.2%) and Sydney (3.4%) and highest in Darwin (5.7%) and Hobart (5.2%). Across most cities house rental yields are lower now than they were at the same time last year, the exceptions are Brisbane, Adelaide and Hobart where they are unchanged. At 3.4%, rental yields in Sydney are the lowest they’ve been since May 2005 and at 3.2 per cent Melbourne yields are at their lowest level since November 2010. The unit market shows different trends to the detached housing market with yields higher or unchanged over the year across most cities. Unit yields are lowest in Melbourne (4.2%) and Sydney (4.3%) and highest in Darwin (5.9%) and Brisbane (5.4%). Unit yields in Sydney are at their lowest level since August 2005 while yields in Melbourne have edged higher over the past month.

Across the combined capital cities, rental rates are recorded at $487 per week and they have risen by 0.1% over the month, 0.7% over the past three months and by 1.7% over the past 12 months. Although rental rates are still increasing, they are doing so at a moderate rate. In fact, the annual rate of growth has been recorded at 1.7% for four consecutive months and hasn’t previously been this low since June 2003. The slow pace of rental appreciation can likely be attributed to the booming level of dwelling construction coupled with high levels of buying activity from the investment segment which is adding additional rental stock to the market and curtailing rental increases. Looking across the capital cities, over the past year Sydney and Hobart have recorded the greatest increases in weekly rents. Rents have fallen over the past three months in Perth and Darwin; along with Canberra these cities have recorded rental falls over the year, down -4.2%, -4.7% and -2.6% respectively.

Looking at the performance of houses as opposed to units there isn’t a great deal of difference in the rates of rental appreciation. House rents were recorded at $492 per week across the combined capital cities in April 2015 compared to $461 per week for units. House rents have recorded stronger growth over the month (0.1%) compared to unit rents which fell by -0.1%. Over the quarter unit rental growth (0.6%) has been lower than houses (0.7%) however, over the past year units have recorded slightly stronger rental growth (1.9%) than houses (1.6%).
Comparing the current rate of rental growth with the 10 year average annual rate of rental appreciation highlights that rental growth is currently sluggish across all cities. In fact, the ten year average annual rate of rental growth is higher than the current growth rate in each capital city. The slower pace of rental growth may be attributed to a number of factors including: a ramp-up in investment purchases resulting in an increase in rental stock, an increase in housing supply which has also added to rental stock and a reduction in net overseas migration decreasing demand for rental stock.

Rental rates are already increasing at their slowest annual rate in more than a decade and the outlook is that a low rate of growth will continue. In fact, with residential construction activity continuing to increase, particularly for inner city units, we would expect that the additional housing supply may result in an even lower rate of rental growth over the coming months. This is likely to be most evident in the markets where new unit supply is surging, being Melbourne and Brisbane and to a lesser extent Sydney.

NZ Property Investors Highly Geared – RBNZ

In the May Stability Report the RBNZ have drilled into the Investment Property sector. They say they will be publishing more detailed data, but the current article makes interesting reading. Housing investors have consistently accounted for over one-third of property purchase transactions over the past decade, with the share rising slightly following the introduction of loan-to-value ratio (LVR) restrictions in October 2013 (figure A1). Sales to investors in the Auckland market have picked up in line with the rise in sales activity since November, and this is likely to be contributing to recent strength in Auckland house prices. Investors are also a key source of new mortgage credit demand, with property investors accounting for approximately one-third of new mortgage lending over the six months ended March 2015.

Although New Zealand has not experienced a financial crisis associated with the housing market, a range of international evidence suggests that defaults on investor lending tend to be significantly higher than for owner occupiers during severe downturns. For example, Irish investor mortgage default rates were around 20 percent higher than total mortgage default rates in the two years following the GFC. Default probabilities were estimated to have been significantly higher than owner-occupiers at any given LVR. Evidence from the UK and the US also finds that default rates were relatively high among investors in severe downturns. The Reserve Bank’s proposal to apply higher risk weights to investor lending, and introduce a differential LVR threshold for investors relative to owneroccupiers in Auckland, is consistent with this evidence.

A key driver of the higher default propensity of residential property investors is higher debt-to-income ratios (income gearing) relative to owner-occupiers. For example, an investor who has borrowed to buy four houses will end up with much larger negative equity relative to their labour income, if house prices fall, than an owner-occupier with just one house and a similar LVR. Higher income gearing reduces the incentive for the investor to continue servicing the outstanding loans, resulting in a greater tendency for investors to default when they have negative equity.

Another possible reason for the higher risks associated with investor lending is that investor house purchases have, in some countries, tended to be concentrated in areas with high expected capital growth. These expectations are often based on recent house price appreciation.

Evidence from the US suggests that increases in house prices prior to the GFC were particularly pronounced in regions where the investor share of house purchases increased. In turn, areas with rapid house price inflation experienced relatively large house price falls in the aftermath of the crisis.

In New Zealand, a significant proportion of property investors have large portfolios, implying a large degree of gearing relative to their underlying labour income. For example, the 2014 ANZ Residential Property Investment Survey shows that 26 percent of surveyed investors held seven or more investment properties (figure A2). Around half of investor commitments are at LVRs of more than 70 percent. Preliminary Reserve Bank survey data suggests that investors tend to make greater use of interest-only loans, which may partly reflect investors’ ability to offset mortgage expenses against personal income for tax purposes. As a result, investor loans are likely to retain a higher level of gearing over the long term than their owner-occupier counterparts.

The risks associated with investor lending are likely to be greatest in the Auckland region. Rapid house price appreciation in Auckland has compressed rental yields, and this is likely increasing income gearing among Auckland investors. Auckland rental yields are at record lows, while national yields are close to their 10-year average (figure A3). Relatively strong capital gain expectations among Auckland investors may explain why they are willing to accept such low rental yields. According to the 2014 ANZ Residential Property Investment Survey, investors in Auckland expected house price inflation to average 12 percent per annum in the region over the coming five years, compared to 8 percent nationwide. CoreLogic data also show that investors in the Auckland region are more likely to use mortgage finance than investors outside the Auckland region.

This Budget Won’t Fix Australia’s Limping Economy. It Shouldn’t Try – The Conversation

The Australian economy is limping along – growing barely fast enough to absorb new workers, with interest rates at record lows, slow wage growth constraining household consumption, and investment relatively weak and declining due to weak business confidence according to Ross Guest Professor of Economics and National Senior Teaching Fellow at Griffith University in his post on The Conversation.

The 2015-16 Budget is not going to turn this around. The deficit is expected to decrease from A$39.4 billion to A$33 billion which, given the margin for error that we’ve observed in past budgets, is neither here nor there in its economy-wide impact. It is the change in the deficit, not the size of the deficit itself, that determines whether a budget is contractionary or expansionary. So this budget will have a roughly neutral impact on the aggregate demand for goods and services.

This is the right fiscal policy stance. In fact, a neutral fiscal policy stance should be the general rule for Australia. It is unwise to attempt to use the Australian federal budget to manage economic growth.

Fiscal vs monetary policy

The Australian economy is periodically buffeted by large swings in commodity prices – base metal prices in particular, the last decade being a prime example. These swings are a major influence on growth in nominal GDP – the dollar value of the goods and services we produce. And this, in turn, is a key driver of the budget balance.

These relationships are illustrated in the chart below. You can see how closely the swings in base metals prices match growth in nominal GDP, especially over the past decade.

Attempting to use fiscal policy to smooth out these fluctuations is fraught with risks. Commodity prices can bounce back quite suddenly and unexpectedly, as they did in 2010-11 following the financial crisis (see chart). Fiscal stimulus is not so nimble.

In fact, the A$42 billion National Building and Jobs Plan – introduced in 2009-10 by then-Treasurer Wayne Swan to stimulate Australia in the aftermath of the global financial crisis – took years to roll out, with some school buildings still to be constructed in 2014.

As the chart shows, commodity prices had by, that time, risen and then fallen again, as had nominal GDP growth. That meant the government’s fiscal stance was out of sync with the state of the economy; it wasn’t clear exactly what cyclical downturn the stimulus was supposed to be smoothing out.

The claim that the Federal Government should have spent more in this Budget because Australia’s debt is low by international standards misses the point.

If you have no debt and then take a four week overseas holiday on your credit card, is it all OK because your debt is still lower than most other people’s? That depends on whether the holiday was better than the alternative use of the funds. Or is it OK because in a couple of years your income will pick up and you’ll be able to pay down the debt then? What if your income doesn’t pick up or you don’t have the discipline to pay down the debt?

This is what governments face when they try to stimulate the economy with borrowed money. Six years after the spending binge that started in 2009, the economy has not bounced back to enable the debt to be repaid as a naïve textbook model might assume. Rather, it sits on the balance sheets of current and future households, through their government, as future tax liabilities which will dampen future growth and cost future jobs.

Managing the swings in the economy is best left to the Reserve Bank of Australia (RBA). The RBA is more nimble than the government when it comes to stimulating aggregate demand.

For example, the RBA increased the cash rate seven times between 2009 and 2011 when nominal GDP recovered (see chart) at the same time as the Government was still pumping out billions of (borrowed) stimulus spending. So we had conflicting policy responses.

Also, the Australian dollar is very responsive to the RBA’s interest rate policy and supports it. It falls when rates are cut (which stimulates tradable goods and services) and rises when rates are increased.

Not so for active fiscal policy – the Australian dollar fights against active fiscal policy. It wants to rise when the government is trying to pump up the economy and fall when the government tries to slow down the economy.

Consumer confidence

Going forward, the main brake on the Australian economy is the lack of business and consumer confidence, as noted in the RBA’s May Statement on Monetary Policy. Consumers seem to be less responsive to lower interest rates than they have typically been. They have not responded much to the eight cuts in official interest rates from 4.75% to 2.25% that occurred between 2011 to 2014.

Why are consumers and business so cautious? One reason is because we have no idea whether a range of government policies in relation to taxation, superannuation, pensions, family benefits and so on, will get through the fractious Australian Parliament. So the less controversial this budget is, the better for consumer and business confidence.

There may be another factor at play. Households may worry that the Australian Government’s rising debt is, in fact, their own future tax liabilities (which they are, or those of their children). This debt has reduced the Government’s net financial worth by 20% of GDP since 2007, according to the latest Mid-Year Economic and Fiscal Outlook (Table D9).

Worse, the Budget Papers project a further 20% decline in the Government’s net worth in the next two years. This is a large transfer of net worth from future households to today’s households. So even though the deficit is stabilising and projected to decline, it is still significant and adding to government debt and future tax liabilities.

If this Budget does not kick-start confidence, we have to ask whether the large build up of future tax liabilities is partly to blame.