Tag: The Conversation

Why ‘digital gold’ won’t ever kill off the real thing

From The Conversation.

In investment terms, a safe haven is exactly what it sounds like: a place of relative safety when times are tough. Traditionally, safe haven assets have been physical, such as gold and silver, the US dollar and the Swiss Franc.

More recently, Bitcoin, and other intangible assets, have been entering this discussion. An example of the latter would be one of the many gold Exchange Traded Funds (ETF), which are shares of gold holdings listed on a stock exchange, a financial claim, or US and German government bonds.

But can these intangible assets really replace the tangible? What changes as our society becomes increasingly digital?

Let’s use gold as an example. Gold is a real and tangible asset, similar to currencies but unlike stocks, government bonds, virtual currencies and other financial claims. Gold is also durable with an effectively infinite longevity and thus completely different to any other asset.

These are the aspects that give gold its prominent position as a safe haven, and they are precisely what the likes of Bitcoin lack.

Real safety versus financial safety

Safe havens provide safety like a harbour does for boats against rough seas. The harbour does not protect the boats against all risks, but provides some protection against storms and big waves.

The question when it comes to intangible assets is whether this same kind of safety can be provided by something that is not real and tangible. In other words, could an insurance contract (a financial claim on an event) provide similar relative safety as gold? The answer is no.

An insurance contract can compensate for a loss, but it does not avoid the actual loss. The loss must be incurred and suffered first, and the compensation is only paid subsequently, with a delay. In other words, whilst the loss is immediate, the compensation is not.

A real safe harbour, in contrast, provides immediate safety and avoids a loss in the first place, i.e. the boat is not destroyed and lost in the rough seas of the ocean but it is protected by the harbour. This loss-avoiding feature may be particularly important if the asset also has some intangible features that can neither be valued accurately nor be fully compensated. Think of something like a unique painting.

Additionally, the insurance contract does not only fail to avoid the loss in the first place, it may also fail to pay any compensation if the issuing company is in financial trouble or bankrupt. This “counterparty risk” is always there but may be large in times of financial stress and uncertainty, and thus when the safe haven feature is needed the most.

Tangibility and durability

We know from behavioural finance that humans do not always act rationally in a strictly financial sense. Some of these decisions are linked to elementary desires, such as the want to possess something that is tangible and additionally signals status and wealth.

Gold has often been referred to as a relic. But from a behavioural perspective, this may also mean it is ingrained in our subconsciousness and related actions. Put differently, as long as humans remain tangible, it is likely that they maintain a desire to hold real and tangible assets.

Very few companies on the US stock exchange, for example, are older than 50 years. By comparison, gold has existed for thousands of years and any gold coin or gold bar will most likely outlive any company and their stocks and bonds. Put together, it is unlikely that a company that sells claims on gold, such as a gold ETF, will beat physical gold’s longevity.

So if you have the choice of physically holding gold coins and bars or buying a financial claim on gold, only the former is providing you with all the benefits of a safe haven.

There is another aspect to this physicality. While the stock market is a great invention, allowing investors to buy fractions of companies (buying a few shares rather than the entire company, for example), this was never a problem with gold. Gold is highly divisible, able to be manufactured and purchased from as little as a few grams right up to 12.5 kg gold bars. The main reason for not holding physical gold is the cost of storage, but this cost does not necessarily outweigh the counterparty risk alluded to earlier.

The horror scenario

Imagine there is a systemic shock that triggers global stock markets to fall by 15% within a couple of hours. You can’t access your online brokerage account immediately as the website is down. And by the time you can, the markets are in free fall and you would lose a third of your wealth if you sold some of your holdings.

It’s in this situation that tangible assets really come into their own. Your real and tangible assets – your gold coins and bars – will still be there and accessible. Trade in them can’t be halted by a company or an exchange, they can’t easily be seized or cancelled by a desperate government, and they don’t rely on a third party (such as an insurer) being able to pay.

Gold and silver will long outlast any of that. The tangible will provide you with some relief.

Author: Dirk Baur, Professor of Finance, University of Western Australia

Home building isn’t a fix for affordability

From The Conversation.

Politicians and the powerful property lobby continue to argue that building more houses is the solution to Australia’s chronic affordability problems.

But a “supply-side solution” – as propounded by NSW Premier Gladys Berejiklian as well as Prime Minister Malcolm Turnbull and Treasurer Scott Morrison – will only work if affordability is just a supply-side problem. Evidence suggests this is not the case. In fact, our analysis shows that Australia is almost a world leader in rates of new housing production.

How Australia compares

One way to assess Australia’s supply performance is to compare it with other developed countries. The graph below compares the number of dwelling completions per 1,000 persons across 13 countries, for the years 2010 and 2015. On this measure, Australia’s new housing production is second only to South Korea’s.

Australia delivers two-thirds more homes per 1,000 persons than the US and four times more than the UK. When we measure supply as a proportion of existing stock, Australia again ranks second with a rate double that of the US.

OECD questionnaire on affordable and social housing; World Bank population growth and total population figures, Author provided

A slightly different approach takes into account population growth. This involves measuring dwelling completions per head of new population. Here Australia’s performance sits in the middle of the pack.

We are delivering just over 0.5 dwellings per head of new population compared to more than 2 in South Korea. This rate is, however, still ahead of the UK and comparable to the US. Again, that suggests inadequate supply is not the major cause of the affordability crisis.

OECD questionnaire on affordable and social housing, World Bank population growth and total population figures, Author provided

State comparisons of supply

At a national level, supply seems pretty healthy. But there are significant state variations. This might, on the surface, be used to explain different patterns of price growth.

The table below shows that New South Wales has produced fewer new homes per 1,000 people than Australia overall over a 30-year period. The difference was particularly marked between 2005 and 2015.

State comparisons of new housing supply. ABS building activity Australia cat. 8152; ABS Australian Demographic statistics Cat 3101, Author provided

However, higher supply output in the other states has certainly not created affordable markets. In NSW, the last two years have delivered significant supply growth yet prices have continued to rise just as fast. So why do prices rise with supply growth?

Demand drives supply

In a market-driven housing system, price stimulates new housing supply. In Australia new supply has responded relatively quickly to price rises (despite the continuous rhetoric from the property lobby about planning).

But there is always some lag due to the time it takes to secure necessary approvals and physically construct property. There is no such lag with demand meaning there is often a sustained mismatch between the two – positive or negative.

In a rising market, development becomes more profitable and land values rise, meaning greater returns for all concerned. Potential future capital gains stimulate investment activity. Price rises also allow owner-occupiers to trade up as the equity in their own dwelling increases.

In such circumstances, increased levels of housing supply do little to satiate demand created by population growth and the appetite of investors.

Western Australia has had an incredible level of housing completions over the last 30 years, as shown in the table, with 2014 and 2015 particularly strong. In the last 12 months, dwelling commencements have collapsed by more than 25%. Prices have been falling slowly for almost three years driven by the contraction in the resources sector and strong levels of new supply.

However, even under these conditions, WA housing affordability shows little sign of improving for those on low incomes. The market still cannot deliver housing for those at the bottom end of the market.

The housing market is simply unable to deliver housing that is affordable to those on lower (and, increasingly, moderate) incomes because there is a minimum cost of delivering housing that meets minimum community standards. This is made up of the land price, the physical construction costs of the dwelling, and the profit required for taking on the development risk.

This is why market intervention and subsidy are essential to deliver options for those on low incomes.

Targeted interventions are needed

Two strategies are needed to deliver affordable housing to the lower end of the market.

First, demand-side measures need to be better targeted to stimulate investment in new supply, particularly affordable rental housing, rather than simply fuelling demand.

Second, any government serious about improving affordability needs to put more resources into the community housing sector. This could be funded in two ways: partly by taxing the windfall gains from development and partly by reallocating existing demand-side subsidies.

The community housing sector can operate counter-cyclically. This means it can maintain housing supply even when house prices stagnate or fall – which is good for the economy.

A bigger community housing sector is the supply solution Australia really needs. The bond aggregator model currently working its way through consultation offers some hope of delivering this expansion.

Targeting supply to deliver housing for those on low incomes and reining in demand-side incentives that fuel prices will make some difference to affordability for those most affected.

There was some encouragement over the weekend. Scott Morrison discussed the rental market and social housing as part of the affordability solution. This was a welcome change from trotting out the tired old supply arguments and threatening to fuel demand through more home ownership incentives.

Let’s hope the treasurer follows through and delivers some much-needed “whole of housing market” thinking in the May budget.

Authors: Steven Rowley, Director, Australian Housing and Urban Research Institute, Curtin Research Centre, Curtin University; Nicole Gurran, Professor – Urban and Regional Planning, University of Sydney; Peter Phibbs, Chair of Urban Planning and Policy, University of Sydney

Despite superannuation changes, one tax loophole remains

From The Conversation.

The Howard government, when flush with revenue, made a bad tax decisions which continue to haunt current policy makers. It removed the tax on the retirement phase of superannuation, this has been partly resolved by current government’s recent changes. But the Howard government also replaced the full taxation of real capital gains with concessional treatment of capital gains (only 50% of gains taxed). This remains as a tax avoidance loophole which both parties acknowledge but are reluctant to act upon.

The reason is straightforward. Assets put into superannuation in the accumulation phase and held until the retirement phase, can then be sold with no, or minimal, capital gains tax payable. This a major incentive to put assets into super and hold them until the retirement phase.

Without further changes to superannuation taxation, this is simply going to worsen the social problem of the well-off adopting tax minimisation strategies by piling as many assets into super as possible. Remember, it will still be possible to contribute up to A$100,000 per annum as non-concessional contributions.

Consequently, the well-off could easily build up a pool of assets of several million dollars or more, which when sold in retirement will still get very, very, favourable capital gains tax treatment under super.

If superannuation assets in retirement are under the A$1.6 million cap, no tax will be payable on capital gains from sales of assets. If assets are above the cap, the tax rate applied to capital gains is 10%.

For example, an asset costing $100,000 and held for 15 years, increasing in price at an average of 7% per annum would be sold for $276,000. If in super, tax payable would be $17,600. If outside of super, on the top marginal tax rate (including levies) of 49%, the tax payable would be $43,096.

If the concession on capital gains tax was reduced (without addressing the concessionary rate in super), the incentive would be even bigger. For example, if the concession was reduced to 25%, tax payable on the capital gain outside of super would be $64,644, an even larger gap to the tax payable in super of $17,600.

Putting $100,000 per annum into super for 15 years with an average 7% capital gain per annum generates a portfolio worth $2.7 million. The capital gains tax savings on this being in super, rather than outside, are more than $1 million!

So, what are the consequences if a brave government elects to reduce the concession applied to capital gains tax? If they make no changes to super tax arrangements there are at least two likely consequences.

First, there is increased incentive for individuals to set up self managed super funds to exploit these tax arbitrage or minimisation loopholes.

Second, despite taxation of earnings on retirement income balances over the A$1.6 million cap, maximising non-concessional contributions into self managed super funds will remain attractive, to take advantage of the difference in capital gains tax rates on assets inside versus outside super – to the detriment of future government budgets.

The consequences for self managed super funds incentives to borrow (via non-recourse arrangements involving trusts) to purchase assets such as property are unclear. As described on one adviser’s website:

Such borrowing will enable trustees to acquire assets over and above the assets that can be obtained from contributions. The caps on contributions can therefore be “overcome” by such borrowings.

However, it is doubtful that there are tax arbitrage benefits from using leverage to purchase assets via super (because higher marginal tax rates mean higher tax deductions for interest on borrowings outside of super).

For reasons of social equity, any general changes to the capital gains tax rate will also need to address capital gains tax within super. Admittedly there is already a lower concession in the case of super (two-thirds of gains are taxed versus one-half).

But that means taxing capital gains in super at only a 10% rate, leaving strong incentives to thwart higher capital gains tax by locating assets within super. Failing to reduce the capital gains tax concession in super would be likely to undo a substantial part of the effectiveness of any general changes the government has already made.

Author: Kevin Davis, Research Director of Australian Centre for FInancial Studies and Professor of Finance at Melbourne and Monash Universities, Australian Centre for Financial Studies

Bligh’s banking appointment is a masterstroke

From The Conversation.

The Australian Banking Association (ABA), backed by the banks’ financial and political clout, has not yet made its mark in the way the mining or gaming industries have. But this is threatening to change. The appointment of Anna Bligh to head up the ABA may represent an important turning point for the organisation.

That she is the first woman to head the ABA connotes some positive PR. But her party-political background is the true advantage. Bligh, a former Queensland Labor premier, is now the chief spokesperson for an industry that fares poorly in the public eye and is persistently at the centre of political firestorms.

The strategic advantage of Bligh’s appointment comes in two key areas of lobbying strategy. For one, she will meaningfully augment the ABA’s power behind the scenes, where lobbying is done directly between businesses and government.

But her primary role will be in the harsh glare of the public. Banking bosses are often disliked, and PR – in this case a form of “public lobbying” – is essential to win over voters on critical policy issues.

Influence in the halls of power

It is important for industry groups like the ABA to keep governments onside. This becomes difficult when, in (effectively) two-party systems like Australia, power shifts between Labor and the Coalition.

Typically, executive boards are stacked with those from a business and PR background, such as the ABA’s outgoing CEO, Steven Münchenberg (a former PR executive with NAB). Otherwise, there will typically be at least one other executive with a background in politics – usually from the Liberal Party – but ideally both parties are represented.

Along with Tony Pearson, formerly Joe Hockey’s senior economic adviser and now an ABA executive, Bligh’s appointment means the organisation has direct lines to decision-makers regardless of which party is voted in.

However, having a Labor Party elder as your CEO brings added advantages. Like other major industry groups, such as the gambling, alcohol, tobacco and mining industries, the banking industry is highly susceptible to public policy changes.

Also like the aforementioned groups, banks seem to have a better relationship with the Liberal Party (as reflected by policy outcomes) than with Labor. It was Labor that introduced the Future of Financial Advice (FoFA) legislation, which placed a fiduciary onus on banks (and others) to put the interests of clients ahead of their own.

Then came the proposed royal commission into banking in the lead-up to the 2016 election. Labor remains committed to this.

The banks’ strategy is clear: beyond her political savvy, Bligh’s appointment brings greater access than a Liberal appointee would. And she will be expected to use it. As the ABA’s head, Bligh will need to meet with her former colleagues to shape policy.

If Labor wins the next federal election, her status as a prominent and well-connected party figure will become exponentially more useful.

But if the Coalition remains in power, then the ABA takes a back seat. Treasurer Scott Morrison has made it clear that he deals directly with the banks, not through “intermediaries” such as the ABA.

The strategy of the banks is strong in that sense. Whether they lobby individually or use the Bligh-led ABA, they will be well represented.

Influence in the living rooms of power

Beyond the advantages of face-to-face lobbying and the ever-more-rapidly spinning “revolving door” between lobbying and politics, the ABA’s principal focus will be to shape public opinion.

These PR efforts acknowledge the power of representative democracy: work on the representatives first, but keep the “demos” – the people – onside, just in case.

As such, the ABA, like all industry groups with a public face, exists to try to convince the voting public that their own best interests are inextricably aligned with the best interests of businesses, whether true or not.

This PR strategy often relies on press releases and media engagement. But when a significant policy threat emerges – like a banking royal commission – the ABA may well rely on the use of “advocacy advertising”. This is where organisations use ads to try to win over public opinion, in turn pressuring the government.

This technique is used excessively in the US. It has a strong track record in Australia too, most notably during the mining tax and pokies reform debates.

To work, advocacy ads wouldn’t even need to make the public like the banks. In the case of unpopular industries, building goodwill is useful but problematic, so scaring the public can be just as effective.

To return to FoFA’s “best interests” example, convincing the public that banks should be able to put their own interests first is difficult. But if banks can suggest that the economy will suffer, and the public might lose monetarily, the strategy can work.

Currently fighting a similar “best interest” clause in the US, its financial services industry made such a case – and appears to be getting its way. The “Secure Family” financial services lobby group has run TV ads such as this:

For an industry as powerful (and rich) as banks, advocacy ads are usually worth a shot. There’s relatively little to lose but a lot to gain.

For policy battles fought in the domain of TV advertisements, it can be tremendously lopsided: those with money (like banks) can pay-to-play. But, problematically, in a system where a plurality or “marketplace” of ideas is critical to democratic ideals, similarly well-funded and advertised counter-argument is often conspicuously absent. By acting and speaking with a unified voice, banks have a significant advantage.

Commercial interests have long recognised the power of lobbying, but more are now realising the importance of harnessing public sentiment too.

There’s Never Been a Tougher Time to be a Central Banker

From The Conversation.

The two central banks that matter most for Australians – the Reserve Bank of Australia (RBA) and the US Federal Reserve (the Fed) – released minutes from their latest meetings this week. And although there were not a lot of surprises, there was a fair bit of detail about what we can expect on interest rates going forward.

The Federal Open Market Committee’s (FOMC) main message was unmistakable -expect interest rate rises, and expect them sooner rather than later:

Many participants expressed the view that it might be appropriate to raise the federal funds rate again fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations or if the risks of overshooting the committee’s maximum-employment and inflation objectives increased.

and that they:

continued to see only a modest risk of a scenario in which the unemployment rate would substantially undershoot its longer-run normal level and inflation pressures would increase significantly.

This is exactly what markets have been expecting, and it seems clear that the balance of risks is no longer that the labour market is too weak or inflation too low, but that the Fed might wait too long to continue its path of rate rises.

The really big unknown is how the Fed goes about unwinding a good chunk of its balance sheet, which involves US$2.64 trillion (with a “T”) of treasury bonds that were purchased as part of its effort to stimulate the economy in the wake of the financial crisis. The Fed also holds around US$1.75 trillion of mortgage-backed securities (“MBSs”).

The natural way to unwind this is by not reinvesting those funds when the securities mature. The Fed gets its money back and doesn’t purchase new treasuries or MBSs.

But it’s more complicated than that. New post-crisis capital rules require commercial banks to keep a large amount of reserves sitting at the Fed. This is now around US$2 trillion. The Fed has to match this liability with assets, like treasuries.

Nobody knows, but my guess is that the Fed shifts MBSs to treasuries over time, but has to keep a large asset side of the balance sheet. This suggests that maybe the whole balance sheet unwinding problem may not be as significant an issue as first thought. But this is genuinely unchartered territory.

At home, the RBA minutes confirmed the ongoing dilemma governor Philip Lowe faces. Like his predecessor, Glenn Stevens, Lowe is trying to manage: unemployment, the Aussie dollar exchange rate, business investment, overall growth, inflation and housing price stability all at the same time, but with only one instrument: the cash rate.

To see this, just look at the opening sentences of the long section of the RBA minutes titled “Considerations for Monetary Policy”. They read as follows:

In considering the stance of monetary policy, members viewed the near-term prospects for global growth as being more positive, although recognised the risks from policy uncertainty in the medium term… Domestically, the economy was continuing its transition following the end of the mining investment boom… Non-mining business investment was also expected to gain some momentum…

Conditions in housing markets varied considerably across the country… Inflation outcomes for the December quarter were much as had been expected and there had been very little change to the forecast for inflation…Labour cost pressures were expected to build gradually from their current low levels…

Wow. That’s a whole lot of targets to try and hit with a single (non-magic, non-silver) bullet. No wonder Dr Lowe has now taken to giving speeches that essentially plead businesses to invest.

It hasn’t quite gotten to “there’s never been a better time to be a business in Australia”. But close. It may, however, be that it’s never been a tougher time to be a governor of the RBA.

Author: Richard Holden , Professor of Economics and PLuS Alliance Fellow, UNSW

APRA fiddles on bank risk while Rome burns

From The Conversation.

Australian Prudential Regulation Authority (APRA) chairman Wayne Byers has made it clear the bank regulator will be cracking down on bank capital levels this year.

Bank capital reserves are a loss-absorber, designed to protect creditors if banks suffer significant losses. That protection, in turn, will – ostensibly – prevent panicked withdrawals by depositors, thereby preventing financial contagion and financial crises.

[DFA notes, its the Council of Financial Regulators that is the coordinating body for Australia’s main financial regulatory agencies. Its membership comprises the Reserve Bank of Australia (RBA), which chairs the CFR; the Australian Prudential Regulation Authority (APRA); the Australian Securities and Investments Commission (ASIC); and The Treasury — so APRA is just part of the problem!]

Byers has decided that Australian banks’ capital levels must be “unquestionably strong” in keeping with the findings of the Financial System Inquiry. But how much capital equals “unquestionably strong”? We don’t know.

What we do know is that the inquiry handed down that finding in November 2014. More than two years have passed and only now is APRA getting a wriggle on.

The problem is that, according to the IMF, when it comes to Tier 1 bank capital, this time last year Australia was ranked 91st in the world. That puts us close to the bottom of the G20, the OECD and the G8. Our position has fluctuated, but at no time during the preceding four quarters have we risen above 60th.

Ranked above Australia were Swaziland, Afghanistan and even Greece. That sounds like, at best, unquestionably ordinary. Maybe even unquestionably weak. But definitely not “unquestionably strong”.

The global financial crisis could’ve led to change

Some argue, determinedly and erroneously, that when functioning correctly bank capital levels are almost magical things. As former US Federal Reserve chair Alan Greenspan once said:

The reason I raise the capital issue so often is that … it solves every problem.

Greenspan, as Fed chair, was ultimately responsible for the health of the US financial system. Having touted capital levels, his tenure ended just before the sub-prime disaster turned into the global financial crisis. This earned Greenspan Time Magazine’s moniker as one of the 25 people most to blame for the crisis.

However, bank capital levels were in place before the crisis hit. The Basel Committee – a sort-of UN for Reserve Bank governors and bank regulators – introduced global standards for bank capital as far back as 1988.

Back then, it set the capital level at 8%. In other words, for every $100 in liabilities, banks had to retain $8 in cash (or close to cash). But this level was simply a reflection of the average of the day.

Codifying the average into a global standard was an excellent trick. No-one was made to feel left out, or inadequate.

Then came the global financial crisis. It resulted in an output loss of somewhere between US$6 trillion and US$14 trillion in the US alone.

The Basel Committee said it was going to raise bank capital levels in response to the crisis. This meant it was going to do more of the thing (bolster capital levels) that had been meant to prevent such a crisis from occurring in the first place, but had failed.

What now?

The Basel Committee’s latest attempt to take action on capital levels involves curbing “internal risk-based models”. These models allow banks to determine how risky their assets are, and therefore how much expensive and unusable capital they have to set aside for loss-absorption, to match the risk profile of their assets.

That’s like you or I determining how risky we are as borrowers, and therefore deciding how much interest we should be charged on the money we borrow.

European banks have pushed back against curbing internal risk-based models. They resent not being able to have absolutely everything their own way. And the Basel Committee has proven to be a push-over.

Australian banks have pushed back too, with a not-so-subtle threat that customers will bear the costs of higher capital levels. If Byers and APRA do what they are supposed to, and what the government told them to do in late 2015, Australia’s banks will need to raise A$15 billion or more to rectify their thin capital position.

That’s $15 billion not earning returns or bringing in bonuses. No wonder our bankers aren’t happy.

And while APRA and Byers have fiddled on this issue and effectively ignored government instructions, and Australian banks remained capital-thin, conditions have arisen that economist John Adams argues may result in an “economic Armageddon” for Australia.

If that happens, guess who will be bailing out the banks? You, the taxpayer.

Author: Andrew Schmulow , Senior Lecturer, Faculty of Law, University of Western Australia

Why small business tax cuts aren’t likely to boost ‘jobs and growth’

From The Conversation.

The Turnbull government’s signature economic policy at last year’s election was a 5% cut in the company tax rate, over a ten-year period, at a cost to revenue estimated to be in excess of A$48 billion. As the government itself has conceded, this now stands very little prospect of being passed by the Senate.

However, there is one element of the government’s proposal which appears to enjoy almost universal political support – the idea that “small” companies should get a tax cut. The only disagreement among the Coalition, Labor and the Greens on this score is how small a company should be in order to be deserving of paying a lower rate of tax.

From the standpoint of good economic policy this is surprising. There has been a lively debate for a while among economists as to whether cutting company tax rates will boost economic growth, employment and real wages – and the extent to which this theory is supported by evidence. But there is no evidence at all to support the notion that preferentially taxing small businesses will do anything to boost “jobs and growth”.

Advocates of tax and other preferences for small businesses often argue that small businesses are the “engine room of the economy” – because, for example, 96% of all businesses are small businesses, or because small businesses employ more than 4.5 million people.

According to the latest available ABS data, small businesses (defined as those with fewer than 20 employees) employed just under 45% of the private sector workforce in June 2015. Despite this, small businesses accounted for only 5.2% of the increase in private sector employment over the five years to June 2015.

By contrast, large businesses (defined as those with 200 or more employees) employed less than 32% of the private sector workforce in June 2015 – but they accounted for more than 66% of the increase in private sector employment over the five years to June 2015.

Employment and employment growth by size of business

ABS Australian Industry (8155.0) 2014-15, Author provided

Similarly, a smaller proportion of these small businesses engage in any of the four categories of innovation which the ABS recognises in its annual survey of business innovation than of medium or large businesses.

ABS, Summary of IT use and innovation in Australian businesses (8166.0), 2014-15, Author provided

So on the basis of the available evidence, a policy which sought to encourage employment creation and innovation via the use of preferential tax treatment would surely preference large businesses, rather than small ones.

However, that would be politically challenging, given that a large majority of voters think that big companies should pay more tax, not less.

What sort of businesses create jobs and growth when tax is reduced?

An alternative approach, which would be much more likely to have positive effects on employment, investment and innovation, would be to tax new companies at a lower rate.

OECD research shows that young businesses are the primary drivers of job creation. And new companies are more likely to be at the frontier of productivity growth.

New businesses are of course likely to be small, at least initially. Confining preferential tax breaks to new businesses – for example, by prescribing that a lower tax rate is only available to a business for the first (say) three years after its incorporation – focuses the assistance on those businesses which are actually likely to innovate, and to create jobs. This is instead of dissipating it on the much larger number of businesses who have no desire, intention or ability to do either.

Preferentially taxing new businesses is therefore much more likely to achieve the stated goals of boosting jobs and growth, and of encouraging innovation, at much lower cost.

In addition to this, preferentially taxing new businesses avoids the perverse incentives that inevitably arise when the eligibility for some form of preferential treatment is determined by a business’ size. This is frequently demonstrated by the reluctance of businesses to put on an extra worker when doing so would render them liable to pay state payroll tax.

Of course, there would need to be compliance measures designed to forestall “rebirthing” of companies in order to prolong access to tax preferences intended to benefit new companies, but that would not be difficult to provide.

The Coalition’s support for a preferential tax rate for small businesses appears to owe more to its long-standing, almost religious, belief that there is something inherently more noble or worthy about owning and operating a small business, than there is about managing or working for a large one (or a government agency). Also that this belief should be reflected in the tax system, rather than basing it on any evidence that taxing small businesses at a lower rate than large ones will have any positive impact on economic or employment growth.

Why Labor and the Greens should support this view is much more of a mystery.

Author: Saul Eslake, ice-Chancellor’s Fellow, University of Tasmania

Australia needs to reboot affordable housing funding, not scrap it

From The Conversation.

Federal government ministers have cast a cloud over funding for social housing and homelessness services, leading to speculation that the National Affordable Housing Agreement (NAHA) may not survive the 2017 budget.

Treasurer Scott Morrison and Assistant Treasurer Michael Sukkar point to the recent Report on Government Services, which shows the number of public housing properties has fallen, as evidence of the NAHA’s “abject failure”. Sukkar said:

We believe it’s crucial that every dollar of spending on affordable housing programs increases the number and availability of public and social housing stock. Clearly, this objective has not been met.

It should be no surprise that Australia’s social housing has been largely static for 20 years. Everything we know about the system tells us it is not funded to even cover the costs of its ongoing operation, let alone growth to meet the needs of an expanding population. Aside from a one-off boost under the 2009 federal economic stimulus plan, social housing has been on a starvation ration for decades.

The whole system system is effectively being run at a loss. So, from the perspective of state governments, building a new public housing dwelling is just one more way of losing money.

The federal government has also long lamented the lack of transparency about how states and territories spend their NAHA funds – about AS$1.5 billion a year. And there are glaring gaps in the evidence about the operations and performance of public housing authorities.

In failing to act on a 2009 commitment to modernise and enhance the Report on Government Services metrics, the states and territories have placed themselves in a weak position to rebut claims of ineffective financial management.

That said, everyone who has any contact with the public housing system knows it to be grossly underfunded. One-off studies occasionally illuminate the scale of the issue. For example, a 2013 New South Wales Audit Office report found a $600 million annual operating deficit for that state’s public housing. But no-one can easily quantify the extent of the problem using routinely published data.

A snapshot of social housing in Australia

Around 320,000 of Australia’s approximately 428,000 social housing dwellings remain under public housing authority control. This stock was amassed through a long series of funding agreements between federal and state and territory governments. These were known as the Commonwealth-State Housing Agreements until their 2009 NAHA rebranding.

Australia has had federal-state housing agreements since the Labor government of Ben Chifley initiated the first one in 1945. AAP

From the first Commonwealth-State Housing Agreement in 1945, the basic arrangement was that the federal government would lend funds to state housing authorities to build houses. The states would cover the ongoing costs from the rents paid by working-class tenants.

And, at least to begin with, the housing authorities did build. They made a significant contribution to housing supply, amounting to roughly one in six houses built between 1945 and 1965.

From the early 1970s, the housing authorities were directed, justifiably, to provide more housing to low-income households unable to pay full “market” rents. However, their capital funding also went into a long decline. With the exception of a brief period in the mid-1980s, housing authorities never again built at their earlier rate.

A number of interlocking problems set in. Social housing’s declining share of the housing stock became more tightly rationed to the lowest-income households. This eroded the system’s rent base. At the same time, its ageing buildings and households with greater support needs increased its costs.

Two landmark studies by Jon Hall and Mike Berry charted the implications of these developments for the finances. At the end of the 1980s, all but one of the housing authorities ran an operating surplus. By 2004, all but one ran an operating deficit.

Various attempts to improve the situation have been made. The 1989 Commonwealth-State Housing Agreement switched federal funding from loans to grants; the 1996 agreement allowed federal funds to be spent on recurrent expenses. In the early 2000s, rebates on social housing rents were reduced, slightly increasing revenue.

Modest amounts of public housing have also been transferred into the hands of not-for-profit community housing providers. Partly, this is to take advantage of the eligibility of community housing tenants for Commonwealth Rent Assistance. But although this often enables these providers to run a small operational surplus, it isn’t enough to fund stock replacement or any significant expansion.

Meanwhile, the overall stock has been eaten away, through market sales of public housing, and run down, through skimping on repairs and maintenance. Both are unsustainable strategies.

Running a system without good data

If the broad outlines of the problem are clear, there are major deficiencies in the data as to the details. The Hall and Berry analysis is now dated. There is no current evidence base that shows transparently and consistently what the social housing system in each state and territory costs, and how these costs are met.

For example, the Report on Government Services purports to show the “net recurrent cost per dwelling” for each state and territory. But this does not differentiate between distinct expenditure components such as management and maintenance.

Our 2015 research found that this metric was a “black box”, subject to implausibly large variations across jurisdictions. These reflected the vagaries of departmental restructures, rather than a sound accounting of social housing operations.

There is little doubt that all public housing authorities are now in deficit. However, the Report on Government Services provides no data on the relative scale of these funding shortfalls. Nor do governments routinely reveal the scale of system costs still met by tenants’ rents, nor through stock sales.

What should a rebooted NAHA do?

Although the NAHA does it inadequately, an enduring program of federal funding for operational expenses is essential to sustain the social housing system. Such funding cannot be “replaced”, as Morrison has suggested, by a government-backed aggregated bond financing model.

The bond aggregator model depends on social housing providers having a durable subsidy from government that pays the difference between their ongoing costs and the revenue from rent that low-income tenants can afford.

Instead, NAHA should be rebooted to deliver three things:

  • capital funding for new social housing stock, distributed according to an assessment of current and projected needs in each state and territory;
  • recurrent funding, distributed according to the number of social housing dwellings in each state and territory and an assessment of reasonable net recurrent costs; and
  • clear accounting by social housing providers for costs of provision and the contributions of tenants, government funding and other sources of income towards meeting these costs.

Many in the social housing world would agree the NAHA framework is far from transparent and that there is no certainty that NAHA money is optimally spent. But a ministerial focus on these issues while ignoring the system’s chronic underfunding smacks of re-arranging deckchairs.

Rather than scrapping the NAHA, the system should be rebooted, to properly fund both the growth and ongoing operations of social housing. This must be done on the basis of clear targets for the level of need to be met and the reasonable costs of providing the service.

Authors: Research Fellow, Housing Policy and Practice, UNSW;Associate Director – City Futures – Urban Policy and Strategy, City Futures Research Centre, Housing Policy and Practice, UNSW

 

Tackling housing unaffordability: a 10-point national plan

From The Conversation

The widening cracks in Australia’s housing system can no longer be concealed. The extraordinary recent debate has laid bare both the depth of public concern and the vacuum of coherent policy to promote housing affordability. The community is clamouring for leadership and change.

Especially as it affects our major cities, housing unaffordability is not just a problem for those priced out of a decent place to live. It also damages the efficiency of the entire urban economy as lower paid workers are forced further from jobs, adding to costly traffic congestion and pushing up unemployment.

There have recently been some positive developments at the state level, such as Western Australia’s ten year commitment to supply 20,000 affordable homes for low and moderate income earners. Meanwhile, following South Australia’s lead, Victoria plans to mandate affordable housing targets for developments on public land. And in March the NSW State Premier announced a fund to generate $1bn in affordable housing investment.

But although welcome, these initiatives will not turn the affordability problem around while tax settings continue to support existing homeowners and investors at the expense of first time buyers and renters. Moreover, apart from a brief interruption 2008-2012, the Commonwealth has been steadily winding back its explicit housing role for more than 20 years.

The post of housing minister was deleted in 2013, and just last month Government senators dismissed calls for renewed Commonwealth housing policy leadership recommended by the Senate’s extensive (2013-2015) Affordable Housing Inquiry. This complacency cannot go unchallenged.

Challenging the “best left to the market” mantra

The mantra adopted by Australian governments since the 1980s that housing provision is “best left to the market” will not wash. Government intervention already influences the housing market on a huge scale, especially through tax concessions to existing property owners, such as negative gearing. Unfortunately, these interventions largely contribute to the housing unaffordability problem rather than its solution.

But first we need to define what exactly constitutes the housing affordability challenge. In reality, it’s not a single problem, but several interrelated issues and any strategic housing plan must specifically address each of these.

Firstly, there is the problem faced by aspiring first home buyers contending with house prices escalating ahead of income growth in hot urban housing markets. The intensification of this issue is clear from the reduced home ownership rate among young adults from 53% in 1990 to just 34% in 2011 – a decline only minimally offset by the entry of well-off young households into the housing market as first-time investors.

Secondly, there is the problem of unaffordability in the private rental market affecting tenants able to keep arrears at bay only by going without basic essentials, or by tolerating unacceptable conditions such as overcrowding or disrepair. Newly published research shows that, by 2011, more than half of Australia’s low income tenants – nearly 400,000 households – were in this way being pushed into poverty by unaffordable rents.

Thirdly, there is the long-term decline in public housing and the public finance affordability challenge posed by the need to tackle this. In NSW, for example, 30-40% of all public housing is officially sub-standard.

“Why the “build more houses” approach won’t work

A factor underlying all these issues is the long-running tendency of housing construction numbers to lag behind household growth. But while action to maximise supply is unquestionably part of the required strategy, it is a lazy fallacy to claim that the solution is simply to ‘build more homes’.

Even if you could somehow double new construction in (say) 2016, this would expand overall supply of properties being put up for sale in that year only very slightly. More importantly, the growing inequality in the way housing is occupied (more and more second homes and underutilised homes) blunts any potential impact of extra supply in moderating house prices. Re-balancing demand and supply must surely therefore involve countering inefficient housing occupancy by re-tuning tax and social security settings.

Where maximising housing supply can directly ease housing unaffordability is through expanding the stock of affordable rental housing for lower income earners. Not-for-profit community housing providers – the entities best placed to help here – have expanded fast in recent years. But their potential remains constrained by the cost and terms of loan finance and by their ability to secure development sites.

Housing is different to other investment assets

Fundamentally, one of the reasons we’ve ended up in our current predicament is that the prime function of housing has transitioned from “usable facility” to “tradeable commodity and investment asset”. Policies designed to promote home ownership and rental housing provision have morphed into subsidies expanding property asset values.

Along with pro-speculative tax settings, this changed perception about the primary purpose of housing has inflated the entire urban property market. The OECD rates Australia as the fourth or fifth most “over-valued” housing market in the developed world. Property values have become detached from economic fundamentals; a longer term problem exaggerated by the boom of the past three years. As well as pushing prices beyond the reach of first home buyers, this also undermines possible market-based solutions by swelling land values which damage rental yields, undermining the scope for affordable housing. Moreover, this places Australia among those economies which, in OECD-speak, are “most vulnerable to a price correction”.

While moderated property prices could benefit national welfare, no one wants to trigger a price crash. Rather, governments need to face up to the challenge of managing a “soft landing” by phasing out the tax system’s economically and socially unjustifiable market distortions and re-directing housing subsidies to progressive effect.

A 10-point plan for improved housing affordability

Underpinned by a decade’s research on fixing Australia’s housing problems, we therefore propose the following priority actions for Commonwealth, State and Territory governments acting in concert:

  • Moderate speculative investment in housing by a phased reduction of existing tax incentives favouring rental investors (concessional treatment of negative gearing and capital gains tax liability)
  • Redirect the additional tax receipts accruing from reduced concessions to support provision of affordable rental housing at a range of price points and to offer appropriate incentives for prospective home buyers with limited means.
  • By developing structured financing arrangements (such as housing supply bonds backed by a government guarantee), actively engage with the super funds and other institutional players who have shown interest in investing in rental housing
  • Replace stamp duty (an inefficient tax on mobility) with a broad-based property value tax (a healthy incentive to fully utilise property assets)
  • Expand availability of more affordable hybrid ‘partial ownership’ tenures such as shared equity – to provide ‘another rung on the ladder’
  • Implement the Henry Tax Review recommendations on enhancing Rent Assistance to improve affordability for low income tenants especially in the capital city housing markets where rising rents have far outstripped the value of RA payments.
  • Reduce urban land price gradients (compounding housing inequity and economic segregation) by improving mass transit infrastructure and encouraging targeted regional development to redirect growth
  • Continue to simplify landuse planning processes to facilitate housing supply while retaining scope for community involvement and proper controls on inappropriate development
  • Require local authorities to develop local housing needs assessments and equip them with the means to secure mandated affordable housing targets within private housing development projects over a certain size
  • Develop a costed and funded plan for existing public housing to see it upgraded to a decent standard and placed on a firm financial footing within 10 years.

While not every interest group would endorse all of our proposals, most are widely supported by policymakers, academics and advocacy communities, as well as throughout the affordable housing industry. As the Senate Inquiry demonstrated beyond doubt, an increasingly dysfunctional housing system is exacting a growing toll on national welfare. This a policy area crying out for responsible bipartisan reform.

Rental insecurity: why fixed long-term leases aren’t the answer

From The Conversation.

The insecurity of rental housing and unsatisfactory condition of many properties are receiving much-deserved media attention following the release of a national survey of tenants.

However, the stock response to the insecurity this revealed – longer fixed-term agreements – is not the answer. The solution to the failure of existing legal protections must take into account the structural features of the rental market, including the mobility of tenants.

The survey, commissioned by Choice, National Shelter and the National Association of Tenant Organisations, presents evidence of a widespread sense of worry, dissatisfaction and injustice on the part of tenants. According to respondents:

  • 75% feel that competition for rental properties is “fierce”;
  • 50% are concerned about being “blacklisted” on a tenancy database;
  • 50% have experienced some form of discrimination;
  • 30% live in properties requiring non-urgent repairs, and 8% require urgent repairs;
  • 11% experienced a rent increase; and
  • 10% reported an angry response after requesting repairs.

Residential tenancy laws cover many of these problems. That tenants are not successfully exercising their legal rights indicates a deeper problem of insecurity in renting. This problem is both structural and legal.

Small landlords and mobile tenants

Small landlords dominate the Australian rental sector: 72% own a single property each. Most (62%) make a net rental loss, so it is important to them that they can switch out of the sector when it suits them.

Research for the Australian Housing and Urban Research Institute (AHURI) indicates that 21% of landlords exit the sector within their first 12 months. By five years, 59% will have exited.

When landlords exit, they might sell to another landlord or an owner-occupier. Older research indicates that the transfer of rental housing into owner-occupation is a significant feature of the Australian market.

These dynamics cause structural insecurity for tenants. They also mean many landlords do not willingly tie up their sole asset in a long fixed term.

Despite the legal and structural insecurity of the sector, most moves by tenants are for their own reasons.

The ABS Housing Mobility and Conditions survey shows that tenants generally are very mobile: 81% have been in their current premises for less than five years. About half of moves between rental premises were for “personal reasons” (including family and employment reasons); 20% were to get more suitably sized housing; and 15% because of a termination notice from the landlord.

This degree of mobility suggests it is not in most tenants’ interest to enter into long fixed terms and the rental liability it entails. That’s not to mention the risk of being tied to a small landlord who is an unknown quantity and has no business reputation to protect.

Residential tenancies law in Australia

Each state and territory in Australia has its own Residential Tenancies Act. These differ in the details but are broadly similar in outline. All provide standard terms for tenancy agreements, processes for rent increases and terminations, and relatively accessible dispute resolution and eviction procedures.

Most do a decent job, on paper at least, when it comes to repairs and maintenance. Generally speaking, landlords are obliged to ensure rented premises are provided fit for habitation and maintained in a reasonable state of repair.

This means tenants are entitled to repairs even if the premises were in bad condition to begin with, and even if they pay relatively low rent. Tasmania is an exception: there, landlords are obliged to maintain premises in the condition in which they were first provided.

Similarly, each state and territory prohibits landlords from interfering in tenants’ quiet enjoyment of their premises. Most expand this right to protect tenants’ “reasonable peace, comfort and privacy”.

These are important protections, even though there may be scope to improve them – for example, by adding specific standards for safety devices and fixing particular legal defects like Tasmania’s. The great problem is that the ability of landlords to give notices of termination without grounds undermines the existing protections in every state and territory.

Without-grounds termination notices give cover to terminations by landlords for bad reasons, such as retaliation and discrimination. This means the prospect of receiving such a notice hangs over tenants when repairs and other issues arise.

What’s the solution, then, to high insecurity?

The legal insecurity of tenants might be improved in several ways.

Under the current laws of each state and territory, a fixed term prevents the landlord from terminating without grounds, and on other grounds such as sale or change of use of the premises, for the duration of the fixed term. It also prevents the tenant from lawfully terminating without grounds.

The idea of long fixed-term tenancy agreements is occasionally raised in the media and has caught the attention of the New South Wales and Victorian governments in their reviews of residential tenancies laws. Both those governments are considering how to facilitate long (five-year) fixed terms, including by altering other aspects of their laws – such as the protections about repairs.

But this approach presents problems of its own. Long fixed terms are unwieldy for landlords and tenants. Trying to make them more useful also threatens other valuable legal protections.

The present structures of the Australian rental sector call for different reforms.

We can reconcile the mobility of tenants with their sense of insecurity if we think of “security” as more than just the legal right to occupy. AHURI researchers have conceived of “secure occupancy” to encompass a person’s ability to make a home of premises and exercise housing autonomy. This includes the ability to confidently get repairs done in one’s premises, or keep a pet – and to freely decide to make a new home elsewhere.

This conception points towards a stronger reform agenda for improving security. Instead of long fixed terms, we should abolish without-grounds termination by landlords.

The law should instead provide a comprehensive set of reasonable grounds for termination, with notice periods and exclusion periods appropriate to each ground. This accommodates our present lot of small landlords, and can be done immediately.

Over a longer term, we should set our housing tax and finance policies to get a more stable sort of landlord. That would be one who operates at greater scale, has a reputation to protect and is less interested in switching out of the sector than in receiving a steady trickle of rents from secure tenants.

Author: Research Fellow, Housing Policy and Practice, UNSW