Tag: The Conversation

Modelling shows how many billions in revenue the government is missing out on

From The Conversation.

The federal government could collect billions more in royalties and tax revenue if it changed the rules on debt loading and adopted alternative royalty schemes in dealing with oil and gas giants, new modelling shows.

Our modelling, funded by lobby group GetUp, found that over the four-year period from 2012 to 2015, Chevron’s average effective interest rate was 6.4%. However, it has been steadily reducing from 7.8% in 2012 to 5.7% in 2015.

We estimated that if Australia adopted a similar approach to Hong Kong to eliminate debt loading abuse, United States oil and gas giant Chevron would have been denied A$6.27 billion in interest deductions, potentially increasing tax revenues by A$1.89 billion over the four-year period (2012-2015).

The issue of debt loading abuse was highlighted last week when the full bench of the Federal Court dismissed unanimously Chevron’s appeal against the Australian Taxation Office (ATO), ordering the company to pay more than A$300 million.

Chevron Australia was using debt loading, where, compared its equity, it borrowed a large amount of debt at a high interest rate from its US subsidiary (which borrows at much lower rates). It did this in order to shift profits from high to low tax jurisdictions.

Based on Australia’s existing “thin capitalisation” rules, there is a maximum allowable debt that interest deductions can be claimed on, in a company’s tax return. Companies can exceed this debt but the interest charges must be at “arm’s length” – at commercial rates.

Chevron’s size and financial strength allow it to negotiate very competitive (low) rates on its external borrowings and this was the main issue in the Federal Court case. As the court has now ruled on what constitutes a reasonable interest rate for inter-company loans, this benchmark will likely be adopted by the ATO.

It can now approach and enforce this benchmark in similar disputes with confidence that companies engaged in debt loading will want to settle rather than engage in a costly court battle.

What the government could save from addressing debt loading

Chevron’s tax avoidance measures meant the interest rate, adjusted for maximum allowable debt, varied only slightly from their effective rate. Our modelling showed that if the ATO had applied the thin capitalisation rules to Chevron’s accounts each year over the four-year period, it would’ve reduced Chevron’s interest deduction by A$461 million and potentially generate an additional tax liability of A$138 million.

We modelled a scenario where Chevron Australia’s interest deductions were limited to the group’s external interest rate, applied to its level of debt. This would have reduced in the interest deduction by A$4.8 billion over the four year period, potentially generating A$1.4 billion in additional tax revenue.

We also worked out what would happen if Australia applied the debt loading rules Hong Kong does currently. Hong Kong disallows all deductions for related-party interest payments, making abuse of the system difficult. According to the latest ATO submission to the Senate tax inquiry, investment in the extraction of Australian oil and gas is almost entirely in the form of related-party loans.

Chevron Australia’s debt is entirely made up of related-party loans. If the Hong Kong solution was operating in Australia, we found that Chevron would have been denied A$6.275 billion in interest deductions, potentially increasing tax revenues by A$1.89 billion over the four-year period.

We also looked at ExxonMobil Australia, which also has high amounts of related-party debt (98.5%), and the Hong Kong solution would have denied ExxonMobil A$2.7 billion in interest deductions, potentially increasing tax revenue by more than A$800 million for the same period.

US oil and gas company Chevron lost a Federal Court appeal against the ATO. Toru Hanai/ Reuters

Changing the PRRT for more revenue

Our report also includes an analysis of the potential for additional revenue from replacing the Petroleum Resource Rent Tax (PRRT) with resource rent systems used in the US and Canada. Oil and gas sales have increased from an average of A$5.96 billion per year between 1988 and 1991, to an annual average of A$33.3 billion between 2012 and 2015, indicating the huge growth in this sector.

We modelled what would happen if the US and the Alberta, Canada, royalty schemes were applied to Australian production volumes and realised prices, to compare returns to those achieved by the PRRT.

The US royalty scheme charges a flat percentage royalty on production volumes, priced at the well-head. The royalty rate was progressively increased in the US from 12.5% to 18.75% between 2006 and 2008.

Based on the data from Australian production volumes and realised sales prices, the US royalty scheme could have potentially raised an additional A$5.9 billion in revenue for Australia since 1988, or A$212 million per year.

However, over the period from 2010 to 2015, the additional revenues would have been almost A$2.5 billion per year. This is because of both the decline in the PRRT revenues, relative to price and volumes, and the increase in the royalty rate in the US.

However, while the US scheme would raise more than the PRRT, the Alberta royalty scheme would raise substantially more revenue than both of these schemes. The Alberta scheme is progressive in nature, meaning the royalty rate increases with the realised price, similar to income levels and personal income tax rates.

The Alberta scheme has been amended many times and the current scheme only started in January 2017, so the full effects of this scheme will not be evident for some time. However, based on the data from Australian production volumes and realised sales prices, we calculate the Alberta royalty scheme would have raised an additional A$103 billion in revenue since 1988, or an additional A$3.7 billion per year.

As the scheme was only implemented this year, these results may be unrealistic, but are indicative of the level of revenue that could be raised. Over the period from 2010 to 2015, the additional revenue would have been A$11.3 billion per year.

The modelling done for our report considers just two multinational corporations, their use of debt loading and the PRRT. Now we can can hope for more revenue collection from many of the multinationals operating in Australia, as a result of the recent Federal Court ruling.

Critically, too often corporations are able to work within Australia’s tax rules to avoid paying for operating here, by constantly arguing they can’t develop business in Australia unless there are tax breaks. Our modelling demonstrates governments need to ensure corporations benefiting from the use of Australia’s resources are contributing the same as they do in other jurisdictions.

Authors: Roman Lanis, Associate Professor, Accounting, University of Technology Sydney; Brett Govendir, Lecturer, University of Technology Sydney; Ross McClure,
PhD Candidate, casual academic, University of Technology Sydney

The man who would rid the world of GDP

From The Conversation.

The South African economist Lorenzo Fioramonti is one of the leading critics of the fact that we measure the well-being of society using a single statistic. In three books, most recently The World After GDP (2015), he argues that the economic activity captured in gross domestic product (GDP) has been the priority for policies and incentives around the world for the past few decades – with disastrous results.

At a recent guest lecture at the Scottish parliament in Edinburgh that was organised by the Carnegie UK Trust, Fioramonti told his audience that GDP is a fundamentally flawed measure of economic performance, let alone well-being.

It has been foisted on the world by rich countries, especially the US, and the political interests that they represent. Just as those who live by the sword die by the sword, any democratic government can expect to lose power if it fails to increase GDP.

Back in 1992 it was James Carville, Bill Clinton’s  director of strategy, who kept repeating to the future president the phrase: “It’s the economy, stupid”. Carville knew President Bush would struggle to defend his handling of the economy. He insisted Clinton repeatedly raise weak GDP growth to show Bush was failing to lead the country.

Sure enough, it helped win the election. Case closed? Not according to Fioramonti.

Simplicity and complexities

Economists like GDP because it is a single statistic. It seems precise. But as Fioramonti pointed out on a day the Scottish parliament had been debating a small fall in Scottish GDP, the initial estimates are always subject to revision. Important variables are only available after taxes have been paid, so the most accurate figures take two or three years. By the time those are published, there probably won’t be any debates in parliament on the subject.

Then there is how to measure GDP. Most countries total all of the income that activities produce, ranging from the wages of individuals to the revenue of companies. But this can lead to all kinds of distortions. Take Ireland, for example. If a UK shopper buys a product online from a retailer domiciled in Ireland, that retailer’s income will be counted as part of Ireland’s GDP.

That would be perfectly reasonable for, say, an Irish shop with a website. But many multinationals put all their European sales through an Irish business unit for tax purposes. Consequently Irish GDP is no longer an accurate measure of the economy’s performance.

When I interviewed Fioramonti after his lecture, he quickly rejected any suggestion that you could solve these problems simply by having a better measure of GDP. This would simply continue to confuse the wealth of the nation with its income, and fail to value other factors important to our well-being such as sustainability. If an offshore drilling company is depleting the Great Barrier Reef, say, focusing on GDP merely continues to prioritise the business success over the environmental damage.

Fioramonti linked the primacy of GDP to the development of Keynesian thought and the perceived need to measure national income after the global slump of the 1930s. His characterisation of the use of GDP in political analysis reminded me of Keynes’ claim that “madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back”.

But Fioramonti believes economists cannot shrug off responsibility for politicians’ use of GDP. The Keynesian economists who adopted GDP growth as a policy target after the war ignored Keynes’ own critique that monetary values cannot truly measure well-being. And when Keynesian demand management failed to achieve strong GDP growth in the 1960s and 1970s, the neoliberal economists who came to the fore compounded the problem by making that growth an even greater priority.

For Fioramonti, weaning the world off GDP is a little like playing chess: you need to win by accepting the rules and conventions of the game before you can change the game. In other words, you need to demonstrate to advocates that, as in the Irish example, GDP no longer measures well-being.

So far so compelling, but I must admit I struggled with his proposed alternative. Fioramonti envisages a “census of assets” – a 21st-century global Domesday Book that would be a record of how people value the assets they need for a good life. It would include everything from jobs to shelter to the surrounding countryside. It would use the language of sustainability and need, and what was included would be subject to a public vote.

I pressed him on how we might value and compare the multiple sources of well-being that are essential to an alternative approach. He was clear it wouldn’t be primarily about assigning monetary values to things.

You would accept that different categories would be measured in different ways and that these would all be part of the mix. Where it made sense you would monitor resource depletion, for instance reducing the value you ascribe to the Great Barrier reef as appropriate.

All these measurements would go towards a national “performance dashboard” – in line with a concept being promoted by the Carnegie Trust. The trust shares Fioramonti’s interest in measuring well-being and incidentally sees Scotland’s efforts to score its government policies using a wide range of indicators as being at the leading edge.

Our discussion was rapidly going away from economics towards something much broader. Fioramonti said he considers even social interactions to be vital to well-being. I certainly agreed with this, but it highlights a problem of practicality. The challenge for developing Fioramonti’s census will be balancing the easily measurable factors associated with well-being with the broader range that are arguably important.

It is not made easier because Fioramonti and other critics of GDP seem to value dialogue rather than statistical measurement. He talks about beating the economists at their own chess game, but he seems to have left the table after an opening gambit.

Author: Robert Mochrie, Associate Professor of Economics, Heriot-Watt University

The real reason Scott Morrison is playing down the budget

From The Conversation.

Despite the Treasurer, Scott Morrison, describing the federal budget as “not a centrepiece”, it has always been regarded as just that – the centrepiece of fiscal policy in Australia.

Any changes in federal taxes and expenditure are intended to achieve good outcomes for Australia’s economy, such as low unemployment, price stability and economic growth. In economic terms, government spending should increase and tax receipts fall during downturns in the economy, and the opposite should happen when the economy is booming. This is how the government is able to balance out cycles in spending by the private sector.

Importantly, the budget is made up of more targeted fiscal policies (referred to as “discretionary” by economists) as opposed to automatic processes (referred to as “stabilisers”). The distinction between the two is important.

Automatic processes refer to when government taxes and expenditure generally increase and decrease with the business cycle. They are automatic because these changes in taxes and spending occur without the government having to do anything.

For example, when the economy is growing strongly, employment increases and unemployment falls. This results in unemployment benefit payments to workers, who were previously unemployed, automatically decreasing.

Also, when the economy is expanding, expenditure and incomes for workers and for businesses rise and the amount the government collects in taxes increases. When economic growth slows or becomes negative, the opposite occurs: the amount the government collects in taxes will fall and expenditure on unemployment benefits will rise.

With more targeted fiscal polices, the government takes actions to change spending or taxes. But although the budget is the centrepiece, it is not a very effective means of managing the economy.

The government and parliament have to agree on changes in fiscal policy. The treasurer initiates a change in fiscal policy through the budget in May each year. This must be passed by both houses of federal parliament, which can take many months (some measures have been blocked by the Senate for much longer).

Even after a change in fiscal policy has been approved, it takes time to implement. Suppose, for example, that parliament agrees to increase spending on infrastructure to create “jobs and growth”. It will probably take several months or more to prepare detailed plans for construction projects.

State or territory governments will then ask for bids from private construction companies. Once the winning bidders have been selected, they will usually need time to organise resources, including hiring labour, in order to begin the project.

Only then will significant amounts of spending actually take place. This delay may well push the spending beyond the end of the low point in the economy that the spending was intended to counteract.

Indeed, if the economy has recovered by the time the construction and related jobs come on board then the government spending will mean a shortage of labour in other parts of the economy and few or no new jobs (unless shortages are filled through migration).

Because the budget is a very difficult means of carrying out targeted fiscal policy, it’s become more important as a centrepiece for the government to set out its broad economic strategy – its goals and how to achieve them. But it seems that both major parties are failing even with this goal.

In recent years the view of most economists has been the need to reduce the structural budget deficit and the level of government debt. In 2016-17 net government debt stood at A$326 billion, and was forecast in last year’s budget to increase until at least 2018-19. There is also quite widespread acceptance that our tax system is in need of reform.

There are two glaring omissions from recent federal budgets of both major parties: any plan to significantly reduce the deficit any time soon, and any proposal to embark on meaningful tax reform.

The Rudd and Gillard governments will be remembered for Wayne Swan’s budgets, which consisted of new spending initiatives including the National Disability Insurance Scheme, the National Broadband Network, and the Gonski education funding reforms, but featured no plan to raise revenues to fund them and manage the huge subsequent debts.

Joe Hockey and Tony Abbott’s attempt in the 2014 budget to address government deficit and debt was regarded as a disaster, resulting in the demise of both as leading politicians. Morrison and Prime Minister Malcolm Turnbull are desperate not to make the same mistake, and this severely limits their capacity to do anything meaningful to tackle the deficit and debt issue.

The major problem with successive budgets is that they have not provided a cogent strategy for improving living standards, including addressing inequity for the most disadvantaged Australians, which can only be achieved through economic growth.

Growth entails taking materials, labour and capital to produce goods and services of greater value that people want at prices they are willing to pay. This is best done by the private sector and cannot arise from wasteful government expenditure, accumulating debt or fiddling at the edges with markets, through such things as changes to superannuation or housing finance.

Growth and jobs can only arise from value-adding activities and government policies which facilitate this such as reducing debt, promoting free trade, reducing restrictions on business and labour market reform. This is hard to do and far more difficult than easy options, which explains why we can expect little from the budget to address real reform.

Author: Phil Lewis, Professor of Economics, University of Canberra

Four charts which should worry you about rising house prices and inequality

From The Conversation.

When we want to measure the economic activity of a country, we tend to reach for the gross domestic product, or GDP. This may be an imperfect measure, but it does allow us to track where the money comes from for every item bought and sold. It tells us whether we worked to earn it through wages, or whether it came from capital income – including stock dividends, rents and capital gains on assets such as housing.

When it comes to the US, economists became used to the idea that the share of GDP attributable to labour income fluctuated around 60% while the remaining 40% was capital income. Then came Thomas Piketty. His 2014 book, Capital in the 21st century explained that the labour share has actually been more unstable over the past century than commonly assumed.

Piketty’s data also showed that the capital share has increased quite significantly at the expense of the labour share over the past three decades. Both in the US and in the UK, for example, the labour share declined from about 70% in the 1970s to about 60% in recent years. This was seized upon as it helps to explain the recent increase in wealth inequality. A large majority of the population gets most of their income almost exclusively in the form of wages. Only a few lucky ones own enough financial assets such as real estate and stocks to earn the equivalent of an annual wage.

More than 80% of the stock market’s value in the US is held by the top 10%. With an average interest rate of 5%, US$1m in stocks are needed to get a return of US$50,000, which is close to the median household income. The person who can make a living from his capital income is certainly no average Joe.

Capital gains

A look at four charts helps to show why this matters, and the impact it can have on those without the means to live on income from capital assets.

Author/Erik Bengtsson and Daniel Waldenström, Author provided

The chart above shows the average capital share for 17 advanced economies from 1875 to 2012. This new dataset, based on work by Erik Bengtsson and Daniel Waldenström, includes more countries than Piketty’s original analysis. The figure confirms the same inverted U-shaped pattern, with high values for the capital share at the beginning and at end of the 20th century, that Piketty found for some major economies such as the US and the UK.

He argued that three major global shocks, the two world wars and the Great Depression, led to a large reduction in wealth around the world. This destruction of capital can also explain the very low capital share in the post World War II period. The recent increase might thus simply represent a reversion towards a value that is more in line with the historic long-run average.

So why is this important for workers? Well, the next chart shows the net capital share in the US from 1929 until 2012.

Author/Erik Bengtsson and Daniel Waldenström, Author provided

Some economists argue that the net share is more relevant than the gross share if one is concerned about inequality. The net share excludes depreciation, the gradual decline in the value of physical capital such as machinery, which is normally included in the GDP figures – even though it is not an income stream to anybody. The data clearly shows the recent increase in the net capital share from a low of 22% in the early 1980s to a high of 30% in 2010. This means that an additional 8% of net national income now takes the form of capital income instead of wages.

So, why is it important if capital takes a larger slice of the pie? If the economy is still growing, surely everybody must win? Well, not quite. The answer is, of course, that capital ownership is highly concentrated. The increase in the capital share effectively means that capital incomes have grown at a faster pace than wages. This leads to a more unequal society since most of the stock market and even a significant portion of real estate is owned by a wealthy few. The more money invested in assets such as property and stocks, the less available to pay workers and boost productivity.

This can work out as a significant hit to the average worker. Net national income in the US was about US$48,700 per person in 2015. Had the net capital share remained at the low value of 22%, an additional US$3,900 per person would flow in the form of wages instead of capital income. This translates to an additional US$10,000 per employed person, certainly a sizeable amount of money.

The importance of real estate

Some researchers, including Piketty, point out that the recent increase in the capital share is related to the rising values of real estate. The next chart shows the average value of real house prices, adjusted for inflation, for the same 17 economies from 1870 until today.

Author/Jorda, Schularick and Taylor, Author provided

House prices stayed fairly constant for almost a century after 1870. However, over the past 50 years real house prices have more than tripled. In some countries such as Australia, they have even increased by a factor of ten over the same time period. Furthermore, these are just national averages. Big cities, including New York, London, and Stockholm, have experienced even larger increases in the value of real estate.

The following chart describes the impact of that and compares the median net worth of families in the US who are home owners with those who are renters. The gap widened significantly during the years of the housing boom. The net worth of home owners exceeded those of renters by a factor of about 46 in 2007. House prices have recovered from the bust in 2008 and are now as high as before the crisis.

Author/Federal Reserve, Author provided

This is a challenge chock full of concerns for policy makers – especially those politicians hoping to win the votes of home owners. But rising house prices, especially in big cities, and the rise of the capital share are both trends which decisively favour asset owners over workers and which slowly chisel out a crevice between the two. Inequality could well increase much further without adequate responses from national governments. These charts should be a simple way of explaining just why things such as subsidies for housing construction in high-demand areas, easing of zoning laws, and higher taxes on capital income should be put on the table by anyone serious about reducing inequality.

Author: Julius Probst, Phd candidate in Economic History with a focus on long-run economic growth, Lund University

Super funds targeted in Shorten’s housing affordability package

From The Conversation.

Labor will promise to ban direct borrowing by self-managed superannuation funds, as part of a housing affordability policy released on Friday to pre-empt the government’s package in next month’s budget.

This “limited recourse borrowing” – where a creditor has limited claims on the loan if there is a default – has increased from about A$2.5 billion in 2012 to more than $24 billion. Almost all of it is in residential or commercial property.

The Murray Financial System Inquiry in 2014 recommended restoring the prohibition that had been lifted in 2007. It warned that “further growth in superannuation funds’ direct borrowing would, over time, increase risk in the financial system”.

Among other measures, a Shorten government would double the screening fees on foreign investment and financial penalties that apply to foreign investment in residential real estate. Foreign investment purchases nearly tripled over the three years to 2014-15. The ALP says the higher fees and penalties would “help level the playing field between first home buyers and property speculators”.

The centrepiece of the ALP housing policy remains the changes to negative gearing and the capital gains tax discount that Labor took to the election, but the latest package surrounds those with several other initiatives.

The opposition announcement comes as the government’s expenditure review committee struggles to stitch together a credible package, and after a much-publicised split among ministers over whether first home buyers should be able to use their superannuation for housing. Malcolm Turnbull last week apparently ruled that option out.

Labor says its package would see the construction of more than 55,000 new homes over three years and increase employment by 25,000 new jobs a year.

The ALP would establish a Council of Australian Governments process to achieve a more efficient and uniform vacant property tax across the main cities.

It would provide $88 million over two years for a new Safe Housing Fund for transitional accommodation for victims of domestic violence, vulnerable young people and older women at risk of homelessness. This would restore cuts made by the Coalition in the 2014 budget.

It would also work with state governments to get better outcomes in the National Affordable Housing Agreement. And it would establish a bond aggregator to increase investment in affordable housing – something the government is moving towards.

Labor would also re-establish the national Housing Supply Council and re-instate a minister for housing, the policy says.

It says that “any housing affordability package that doesn’t involve reforms to negative gearing and the capital gains tax discount is a sham”.

“Demand for housing is being turbo-charged by unfair, unsustainable and distortionary tax concessions for investors.” The ALP’s long standing policy is to limit future negative gearing to new housing and reduce the capital gains tax discount from 50% to 25%.

Labor says the super funds’ ban “will prevent the unnecessary buildup of risk in Australia’s superannuation system, reduce future calls on the aged pension as a result of a less diversified superannuation system and make the financial system more resilient in the face of potential economic shocks”.

It says that although foreign purchases in residential real estate account for a relatively small amount of overall annual purchases, the amount has grown by 275% in the three years to 2014-15.

Under the Labor policy, from July 1 2019 the foreign investment application fee would go from $5000 to $10,000 for a property up to $1 million; from $10,100 to $20,200 for one between $1 million and $2 million, and from $20,300 to $40,600 for one between $2 million and $3 million.

For foreign buyers who acquired dwellings without approval, the criminal penalty would be increased to $270,000, and $1.35 million for a company.

Author: Michelle Grattan, Professorial Fellow, University of Canberra

For renters, making housing more affordable is just the start

From The Conversation.

Deloitte Access Economics’ Chris Richardson recently suggested that young Australians would be better off renting than trying to buy a house. He argued:

… rents today make a lot more sense than housing prices.

This may be true. However, the situation for renters is far from clear-cut. Rents continue to increase in Australian cities, and are out of reach for low- and very-low-income earners.

Renters also face substantial housing insecurity. In Australia, 50% of renters are on a fixed-term one-year lease; 20% are on a month-to-month “rolling” lease.

For renting to become a truly viable, long-term alternative to home ownership, greater rental affordability and security is needed.

Rental affordability

Longer-term structural changes to tackle housing affordability, including boosting the supply of social housing and increasing tenure diversity, will be essential. There are some promising moves, including the recently announced proposal for a bond aggregator model to fund social and affordable housing.

Failing a substantial increase in affordable housing, there will be a need to increase rent assistance payments, particularly in high-cost regions.

This acknowledges that housing costs differ across the country and that many low-income earners need to remain in high-cost regions. This includes older people whose social and family networks are in these regions, and people who work in these areas.

Many industries in high-cost cities are dependent on people who earn low and very-low incomes. These people have a right – and need – for affordable, secure housing – and a house that is a home.

Affordability is the thin end of the wedge

For renting to become a true alternative to home ownership, greater rental security is needed.

To move toward secure rentals we need to reward long-term investment. One example might include encouraging institutional investors, including superannuation companies and other businesses that invest in large amounts of rental housing, who are in it for the long haul.

However, there is no reason to assume that institutional investors will offer more affordable rental properties, or be any better landlords than so-called “mum and dad” investors. We therefore need to pursue changes to rental laws to ensure renters, including the growing generation of long-term renters, can experience a secure sense of home. Specific changes include:

Removing no-grounds eviction. The perceived risk of eviction leads to stress for renters. And the right to no-grounds eviction can lead to retaliatory eviction by landlords when tenants exercise their rights, including rights to maintenance and repairs.

The Tenants’ Union of NSW has called for a balancing of landlord and tenant interests through tenancy laws that specify reasonable grounds for termination.

Such laws could follow the German example. In Germany, rental laws ensure security of tenancy while retaining the right of landlords to terminate a lease in certain circumstances, such as if a tenant violates the lease agreement (for example, by not paying rent) or if the landlord requires the property for personal use.

Rent increases are sometimes a “backdoor” way of evicting tenants. In a recent survey, 11% of renters reported receiving a “rent hike after requesting a repair and 10% said that their landlord or agent became angry”. We need stronger regulation of rent increases and stronger penalties for unreasonable increases.

There are precedents for this in other jurisdictions. Germany again provides a great example. There, rent increases are allowed less frequently. And they:

… must be based in the rents of three similar dwellings or a database of local reference rents and rents may not increase more than 20% over three years.

Ensuring the right to make a home. Rental laws need to ensure the right of tenants to make their house into a home, including making cosmetic changes to a property, ability to keep pets, and allowing alterations that would allow an older person or person with a disability to live there.

Some older renters I have interviewed recently have had to move after these types of adjustments were rejected by landlords who thought age-related modifications were not attractive.

In New South Wales, the right to make changes that would ensure a property is liveable for people with different housing needs is being considered as part of the current residential tenancy law review. However, the right to make cosmetic changes is excluded.

Popular wisdom often suggests that tenants and landlords have different interests. In fact, they have very similar interests. Both benefit from secure tenancies and a property that is well maintained and cared for.

Failure to ensure rental affordability and security will require a raft of policy changes in other areas, including pension income calculations that assume home ownership. It will also condemn a generation of long-term renters to increasingly unaffordable and insecure housing.

Author: Emma Power, Senior Research Fellow, Geography and Urban Studies, Western Sydney University

Social impact investment can help retirees get the housing and care they need

From The Conversation.

A recent report raised concerns about the erosion of retirement income by ongoing rental or mortgage payments.

The report by the Australian Institute of Superannuation Trustees is timely, given the Australian aged pension system is predicated on an assumption of outright home-ownership. Yet increasing numbers of people are still paying mortgages after retirement, use superannuation to pay off mortgage debt, or do not own a home and must rent.

Any significant decline in home ownership or equity in a home also has impacts on higher care needs. This is because older people will not have an asset to sell to fund the bonds required to enter aged care accommodation.

Author provided

These developments – and the increasing housing insecurity for older people – potentially undermine the sustainability of Australia’s retirement system and, in turn, public finances.

Addressing the problem

Social impact investment strategies could fund more affordable housing and aged care for seniors.

Social impact investments are:

… investments made into organisations, projects or funds with the intention of generating measurable social and environmental outcomes, alongside a financial return.

Impact investment in Australia may take a variety of different forms. It can be organised through direct equity investment, acquisition of units in a mutual fund, debt, venture capital, social impact bonds or other fixed income mechanisms, which might combine blended social impact and financial return.

The sources of investment are equally diverse. These may include philanthropists, funds, businesses, government, private investors, or a combination of two or more.

In Australia, social impact investing is a relatively recent phenomenon although it is developing rapidly in a variety of areas. Impact investing in Australia will be worth $A33 billion by 2022 and extends to a diverse range of investments.

In relation to housing support, examples include the Aspire Social Impact Bond, which targets people experiencing long-term homelessness, and Homeground, a not-for-profit real estate service.

In relation to housing developments, projects such as the innovative CapitalAsset partnerships instigated by ShelterSA. The project aims to collaborate with developers, landowners and investors to build affordable housing developments through a property unit trust.

Housing is likely to be a focus area of social impact investment partnerships between Social Ventures Australia and organisations such as HESTA and Macquarie.

Financing is the key to increasing stocks of affordable housing. It seems the federal government is likely to institute a bond aggregator model involving institutional investors and affordable housing providers.

Retirement housing issues have not been a focus for social impact investing in Australia or elsewhere. However, it is suggested this form of investing could tackle the problems outlined in the Australian Institute of Superannuation Trustees report in three ways.

(Almost) home owners

For those who must maintain a mortgage into retirement, or who want to avoid using most of their superannuation funds to pay off the mortgage, thought could be given to offering lower-cost loans or products akin to reverse mortgages at lower than commercial rates.

Alternatively, under a shared equity arrangement – where reduced payments are made until the sale of the property or the death of the owner/s – the property could be sold and the sale price shared by the older person to put towards care or the estate and the lender.

Social impact investment lenders could finance this in the same way as banks do but at reduced rates. There would still be a healthy return, and older people could live better in retirement with reduced payments but secure in the knowledge they do not have to leave or lose their home.

Regarding the older people who rent, again social impact investing could focus on ensuring that any housing projects developed have a certain percentage of the accommodation available for older people.

Models proposed for social impact investing in affordable housing could be applied to ensure this accommodation is suitable for older people.

Wrap-around services

In both cases, the financing models could be supported by social impact investing provided for support services.

For example, wrap-around services, such as those provided in the Newquay project in Britain, aim to keep older people in their homes and out of hospitals and aged care.

If housing costs are a problem for people in retirement, that’s also going to hamper their ability to pay for care. shutterstock

Ripe for repair

Social impact investing could mobilise private capital to work with not-for-profits to attract investment funds. Grace Mutual has mooted such a project in Australia.

Furthermore, social impact investments could work in areas, such as rural and regional Australia, that are traditionally left to government because of low population and problems with profitability and economies of scale.

Sabina Lim recently suggested the services gap in health and aged care is ripe for social impact investing in Australia.

It’s time to bridge the gaps

Governments alone cannot bridge the gaps and support affordable housing for seniors.

Although government will certainly continue to play a significant role, impact investment should be encouraged as a way to resolve financing and development issues in meeting seniors’ needs for accommodation and care.

Such involvement can be fostered through partnerships between government, NGOs and private investors, together with taxation and other financial incentives. Legal, policy and planning impediments to financing and investment in seniors housing also need to be removed.

Importantly, we need other players in the market who are prepared to invest in affordable housing and aged care for Australians in retirement.

Authors: Eileen Webb, Associate Professor, Curtin Law School, Curtin University; Gill North, Professorial Research Fellow, Deakin University; Richard Heaney, Professor of Finance, University of Western Australia.

Here’s how superannuation is already financing homes

From The Conversation.

The federal government is split on whether first home buyers in Australia should be allowed to use part of their superannuation for home deposits. But what the more strident critics miss is that Australia’s superannuation system already channels a significant proportion of retirement savings into housing.

It does this not via the traditional route of people buying a house outright, but rather through an indirect channel, by transforming the household’s compulsorily acquired superannuation equity into mortgages from commercial banks and other financial intermediaries.

Statistics from the ABS (December 2016) show that for every A$1 of assets managed by the superannuation sector, approximately 27 cents is directly financing Australia’s banking sector. This is via superannuation holdings of bank deposits (14c in the dollar), bank equity (7c in the dollar), and other bank liabilities (6c in the dollar).

What do banks do with this 27c? The ABS reports that 38% of bank financial assets are long-term loans to households. We have cross-inspected this data with figures from the Australian Prudential and Regulation Authority (APRA) and found that nearly all of these loans are mortgages.

This suggests that at least 10c of every A$1 of superannuation assets is indirectly financing house purchases via commercial bank debt.

But this also excludes other indirect financing of banks by superannuation. For example, the portfolios of non-money market mutual funds and other private non-financial corporations are also heavily weighted towards funding banks (24% and 36% of their assets, respectively), and superannuation funds allocate 6% and 24% of their funds to these agents respectively. This potentially adds a further 4c in every A$1 of superannuation assets that ultimately results in debt financing of housing.

Why using super for housing might be good idea

One of the merits of allowing households to use their superannuation to supplement their housing deposits would be to reduce unnecessary and expensive financial middlemen. Under the present system, the money from superannuation that finds its way into housing finance does so by passing through chains of two or more intermediaries. This means that it incurs management expenses at each step.

The first link in the chain is the superannuation sector (with an average expense ratio of 0.7%). Next is one or more financial intermediaries, like banks. A plausible estimate of the banking sector’s expense ratio, by our calculations, is 1% to 2.3% of bank assets.

Total expenses through the intermediation chain could therefore be as high as 1.7% to 3%. These expenses might be lower under a housing equity super access scheme.

Another potential benefit relates to the accumulation of debt and its consequences for financial stability.

Most of the money people put away into superannuation, because its compulsory, would have otherwise been used for other types of saving. If you look at the assets in a household’s balance sheet, it is clear that housing equity (representing 65% of non-superannuation assets) is the household’s preferred savings vehicle.

It is possible that growth in compulsory superannuation has contributed to growth in household debt in two ways. First, by frustrating people’s ability to finance home ownership through their deposit. Second, by increasing the supply of mortgage finance, as superannuation savings are recycled through the financial system, and converted to mortgages by the banks.

The risks with the plan

One concern about letting people divert money into buying a house is that their income in retirement could suffer as a result. To mitigate the risk of this happening, any policy on this would need to record and track the values of super funds’ home equity stakes (just as super funds presently track values for the traditional assets they hold).

But retirement income is determined by total net assets, not superannuation assets alone. In this context, home ownership provides retirees an important stream of stable tax-free, inflation-protected, income. This is recognised by the Association of Superannuation Funds of Australia benchmarks for “modest” and “comfortable” retirement income.

These assume that retirees own their home outright. So the decline in home ownership is a significant threat to the adequacy of Australia’s retirement income system.

A second risk is that the policy could further raise house prices, reducing affordability and exposing retirement savings to a house price collapse. In the present house price environment, this is a real risk, which would need to be monitored. But the policy’s two main merits (reducing intermediation costs and improving financial stability by reducing gross debt) are long-run benefits that will continue to hold beyond our current point in the house price cycle.

APRA also already monitors risks associated with housing credit growth, and has the tools, and the willingness to use them, should the policy promote undesired house price growth.

There are reasons to expect that a policy allowing first home buyers access to super will not lead to net growth in housing finance. Superannuation funds are already required by APRA to understand their underlying asset exposure risks. So super funds might try to maintain their total exposure to property risk under this policy, for example by reducing their exposure to the banks.

Authors: James Giesecke, Professor, Centre of Policy Studies and the Impact Project, Victoria University;
Jason Nassios, Research Fellow, Centre of Policy Studies, Victoria University

ATO data shows inequality is in everything from super to the property market

From The Conversation.

The Australian Taxation Office (ATO) has released data for 2014-15 that paints a picture of how much Australians earn and what they claim in tax concessions. We asked our tax experts to tell us what the data says to them.

John Daley and Danielle Wood, The Grattan Institute

The latest data from the ATO is consistent with what we’ve seen in the past. It shows that people with high-income occupations – doctors, lawyers, and others – are more likely to use negative gearing than the nurses and teachers on whom Treasurer Scott Morrison focuses when he tries to justify retaining negative gearing. It also shows that negative gearing is typically worth four to five times more for doctors and lawyers than nurses and teachers.

Author provided

The tax data shows that with falling interest rates, fewer landlords are negatively geared, and the average loss is also falling. Overall the investor property market seems to be concentrating a little, with slightly fewer landlords but more investment properties per landlord.

Author provided

Negative gearing has lots of problems. It costs the budget a lot of money, distorts investment decisions, increases house prices, and reduces home ownership, while doing little to increase supply.

The government claims it should nevertheless be retained because it’s primarily an investment strategy for “mums and dads”. But the detailed tax data from previous years shows that about two-thirds of the benefit goes to the one-fifth of taxpayers with the highest income before the negative gearing deduction.

We will have to wait until later this month for the release of more detailed data to check that this is still true.

Professor Fabrizio Carmignai, Griffith Business School

This data delivers a simple, probably not unexpected, but still concerning message: inequality in Australia is increasing.

We can see this in terms of the growing gap between the richest and the poorest suburbs, as well as an increase in dispersion across all suburbs.

For example, the data published yesterday indicates that average taxable income in the ten poorest postcodes was only 11% of the average taxable income in the ten richest postcodes. A decade ago, in 2004-05, income in the ten poorest postcodes was 21% of income in the richest postcodes.

In fact, while the average income at the top of the distribution has grown by 30% in a decade, average income at the bottom has actually declined by 33%. If we look at the overall dispersion of incomes by postcode, we can see that this has gone up by approximately 25% in ten years.

Whichever way we look at it, the conclusion is that there is more income inequality today than ten years ago.

The other interesting aspect to the data is that the richest postcodes today are more or less the same as ten years ago. Indeed, seven of the top ten postcodes in 2014-15 were already in the top ten in 2004-05. But this same trend is not observed at the bottom: none of the ten poorest postcodes today were in bottom ten in 2004-05.

And there is some bad news for Queensland in particular: the proportion of the state’s postcodes in the bottom ten has increased considerably, from three out of ten in 2004-05 to seven out of ten in the latest data. This data might be indicative of a growing poverty problem in this state.

Associate Professor Helen Hodgson, Curtin Law School

The ATO’s data clearly shows that the self-managed superannuation fund (SMSF) sector is not only continuing to grow, but is used primarily by people with the ability to make higher contributions; either high income earners or those late in their careers.

Members of self-managed superannuation funds made significantly higher contributions and have higher balances than members of Australian Prudential Regulatory Authority (APRA) regulated funds.

The data shows that on an individual basis, the median contribution to a SMSF was A$20,000. Meanwhile, members of APRA funds made median contributions of A$4,507.

Similarly, the super balances of members of SMSFs are significantly higher than APRA funds. SMSF members have median balances of A$289,483, compared to just A$32,734 for those in APRA regulated funds. The data also shows that a small proportion of people have very high balances, which is reflected in the difference between the median and mean balances in the statistics.

Two of the forthcoming changes to superannuation will limit contributions and impose a cap on balances, which should impact higher earners. Most people who made contributions in excess of A$25,000 are over 45 and earned more than A$180,000.

But the changes to the superannuation system will not take effect until July 2017, so it is too soon to know how that will impact superannuation funds. However the division between the self-managed and APRA regulated funds is clear.

Authors:Jenni Henderson, Editor, Business and Economy, The Conversation; Josh Nicholas, Deputy Editor Business & Economy, The Conversation; Interviewed: Danielle Wood, Fellow, Australian Perspectives, Grattan Institute; Fabrizio Carmignani, Professor, Griffith Business School, Griffith University; Helen Hodgson, Associate Professor, Curtin Law School and Curtin Business School, Curtin University; John Daley, Chief Executive Officer, Grattan Institute.

How the blockchain will transform housing markets

From The Conversation.

An emerging technology, blockchain, could transform the way we buy and sell real estate by doing away with the hidden costs and inefficiencies of our housing markets.

Blockchain is an online ledger that records transactions. It’s capable of recording the movement of any kind of asset from one owner to the next.

It’s public and isn’t owned by any one corporation, there are no charges to record transactions. Its openness ensures the integrity of transactions and ownership, as everyone involved has a stake in keeping it honest.

This means there are fewer intermediaries; less middle-men who increase the costs and time to complete a transaction.

There are risks associated with the system as it’s only as strong as the code that supports it, which has come under attack in the past. Despite this, examples from overseas show it is possible to apply this technology successfully to our housing market.

Problems in how the property market is run

For buyers able to find the right property, secure a mortgage and save a deposit, they must also pay for a range of so-called “hidden costs”. These are additional payments associated with the transaction over the cost of the home itself. Many legal and title-related costs would become near-obsolete in a blockchain system.

The combined costs of title registration, title insurance, and legal fees associated with register the property transfer approach A$1,000 on the average Australian house. Costs continue to rise as the prudent buyer undertakes further due diligence, through building inspection documentation, previous sales records and so forth.

On top of the financial cost, it then typically takes over a month to settle a real estate transaction in Australia. The blockchain system can speed things up, as currently tedious checks undertaken by hand, move to an automated system overseen and approved by the relevant stakeholders.

There is also the risk that land titles offices with a single database simply get things wrong too. In 2016 it was reported that 300 incorrect certificates had been issued in NSW, with 140 of those being recent property buyers affected by government plans for major motorways in Sydney’s west.

There are now concerns that the system’s quality could be compromised in several states, including NSW and South Australia, as land titles offices become privatised.

A blockchain real estate market

If blockchain were applied to the property market in Australia, every property would be encoded with a unique identifier. Property IDs already exist in most land registry systems, so these would need to be migrated to a blockchain.

Next, the blockchain ecosystem then needs to have defined who the people behind the transaction are, those stakeholders that include the owner, lender, and government.

Transactions of property are conducted via “smart contracts” – digital rules in the blockchain that process the agreement and any specified conditions. Buying and selling could still take place via agents, or the smart contract can be advanced to incorporate the sale rules and make this decision automatically. The blockchain for each property grows as transactions are added to the ledger.

A housing market without agents, conveyancers and a land-titles office may seem decades away, but a handful of countries have already piloted blockchain land registration system.

In Australia, our current land titles system is among the world’s best, but it is not infallible. A range of hidden taxes and transaction costs increase market inefficiencies.

And while the electronic system Property Exchange Australia or PEXA, has brought us to the point of a near paperless property market, it’s still an intermediary between the parties and the record of the transfer in the Torrens system – our current land title system.

The added advantage of a blockchain system is in eliminating risks, in particular the risk of records being accessed fraudulently and altered or deleted because it is a permanent and immutable record. This means that a huge amount of computing power would be required, probably along with some collusion, and the alteration is easily detected across the ledger. That’s not to say the blockchain system is perfect.

Blockchain’s advantage in restricting any changes to historical records becomes a disadvantage when incorrect or fraudulent entries are added. Digital currency managers, Ether and Bitfinex, learned this the hard way through cyber attacks.

Last year these attacks siphoned off over US$50 million in ether tokens from The DAO, the largest crowdfunded venture capital fund. This breach led to a controversial split of Ether into two separate active digital currencies.

Only months later, Hong Kong-based crytocurrency trading firm, Bitfinex, had the equivalent of US$68 million stolen by hackers in a security breach reminiscent of the hack that bought down Mt Gox in 2014. It is little comfort to cautious market regulators that the thieves behind these attacks can not spend it without revealing their identity on the blockchain.

These hacks demonstrate that blockchain systems are only as secure as the code which supports them. As a nascent technology, its cracks are detected only when they are exposed.

Where blockchain has worked before

Sweden became the first western country to explore the use of blockchain for real estate in July last year. At the time, the Swedish Land Registry partnered with blockchain startup ChromaWay to test how parties to a real estate transaction – the buyer, seller, lender, government – could track the deal’s progress on a blockchain.

Other countries at the forefront of blockchain for real estate include The Republic of Georgia, Honduras, and Brazil which announced a pilot program earlier this month. While this might seem like a disparate list, it’s in these countries where the long-term potential of a blockchain for real estate are most significant.

Systemic corruption and insecure database management in these countries, and many other emerging economies, is seen as a major constraint on growth and prosperity. Why would you invest in a house, or any other asset, if there is a distinct possibility that the record of your ownership could simply disappear?

With ever increasing demands for improvements to transaction efficiency and local real estate industry giants like CoreLogic appointing research teams dedicated to new technology applications, it might not be long before we see a real estate blockchain system in Australia.

Author: Danika Wright, Lecturer in Finance, University of Sydney