Opposition Leader Bill Shorten’s line of attack during the leaders’ debate focused squarely on the Coalition’s long-term plan to cut the company tax rate from 30% to 25%.
Twice during the debate Shorten said the proposed tax cuts equated to giving A$7.4 billion over ten years to Australia’s big four banks (National Australia Bank, the Commonwealth Bank, ANZ and Westpac).
Is that right?
Checking the source
When asked for a source to support that assertion, a Labor spokeswoman referred The Conversation to modelling conducted by think-tank The Australia Institute.
The Labor spokeswoman said:
Bill was emphasising the clear point of contrast in this election campaign, which is that Malcolm Turnbull wants to spend $50 billion giving huge companies a tax cut while Labor wants to invest in schools, Medicare and growing good jobs.
The Australia Institute modelling
In a press release, The Australia Institute said that for their economic modelling:
The value of company tax provisions was derived from 2015 full year annual reports for the big four banks. That figure summed to $11,123 million. That figure was projected forward to 2026-27 to give the no-change scenario.
To arrive at the figure of $7.4 billion, The Australia Institute modelling assumed bank profit would increase in line with nominal Gross Domestic Product. Under this assumption, the amount of tax payable would also increase in line with nominal GDP. This would give nominal increases of:
2.5% in 2015-16;
4.25% in 2016-17; and
5% in 2017-18 and subsequent years.
As the think tank noted in its press release, the company tax cuts would not affect the big banks until 2024-25. That’s when the 30% company tax rate will fall to 27% for all companies with further reductions of 1% per year, hitting 25% in 2026-27.
The Australia Institute calculated the following results:
On these calculations, the “$7.4 billion over the next ten years” claim is not a fact. But it’s also not an unreasonable guesstimate – although it is, of course, really over the three years from 2024-25 through 2026-27. There is no advantage to the big banks over the first seven of the next ten years.
According to the Australian Taxation Office, the four big banks paid a total of $9.5 billion in company tax in the 2013-14 financial year.
The government has proposed increasing the turnover threshold below which the rate of company tax payable is 27.5%, from $10 million in 2016-17 to $1 billion in 2022-23.
The government’s proposed policy says that the company tax rate for all companies (including the four big banks) with turnover exceeding $1 billion will fall from 30% to 27% in 2024-25, and then by a further one percentage point in 2025-26 and another percentage point (to 25%) in 2026-27.
So, on that basis, The Australia Institute’s maths checks out.
A grain of salt
As with all economic modelling, this modelling and any claims based on it should be taken with a large grain of salt.
Any assumption about the banks’ profit growth over the next ten years is entirely arbitrary, and I have no idea whether it is at all justified. Only time will tell.
If the banks’ profits grew by only 2% per annum over this period, then the benefit to them from the cut in the company tax rate proposed by the Coalition would be “only” $4.8 billion; if they grew by 10% per annum the benefit to them would be $12 billion (over the three years from 2024-25 to 2026-27).
Verdict
Shorten’s statement relies on modelling assumptions made by The Australia Institute think-tank about bank profit growth. It is not a statement of fact but rather a guesstimate. It is not an unreasonable guesstimate, but depends entirely on whether the think tank’s assumptions about bank profit growth come true or not. – Saul Eslake
Review
This article correctly reflects the analysis of The Australia Institute upon which the claim of a “windfall” for the large banks has been based. As the author notes, the baseline figure is a guesstimate based on not unreasonable assumptions about the growth of the economy and the impact of the proposed business tax cuts upon bank profits, albeit seven years out. – Pat McConnell
Author: Saul Eslake, Vice-Chancellor’s Fellow, University of Tasmania; Reviewer, Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie University
Imagine not being able to go on holiday because you cannot get travel insurance or it costs more than the trip itself because of your health. Or what about being denied free car insurance with your new car or turned down for a mortgage because you’re too old. Then there are a whole host of banking services that aren’t easy to access – from sorting out your current account to managing your pension and savings – if you’re unsure about the internet or cannot afford to go online.
These are common experiences for millions of people across the UK who are denied access to everyday financial services because of disability, disease, age, lack of digital skills or because of where they live, and are the findings of a paper I co-authored, published by the Financial Conduct Authority, the major UK regulator.
In the course of the research, we came across numerous cases. For example, one man in his 30s and working for the armed forces was refused an extension to his mortgage. The reason was that it would take the term past the age of 60, the compulsory retirement age for the Armed Forces, even though he intended to work longer and his state pension would not start until the age of 67.
In another case, Alison was living with terminal cancer and was given two to five years to live though was in relatively good health. When arranging a holiday, she was turned down flat by many travel insurers while others said they would call her back but never did. In the end she went with the only firm that would cover her, paying £1,300 for insurance for a ten-day cruise in Europe.
Computer says no
Our research suggested that problems like these are only likely to grow as more services shift online and use automated processes that are not set up to deal with non-standard, “imperfect” consumers. This doesn’t even include people who live in rural areas with few bank branches and inadequate broadband and mobile reception, or the 17% of over-55s who have no access to the internet at all.
Many of us will have experienced the frustration of online systems that don’t quite fit our real-world circumstances. For “imperfect” consumers, the problem is far worse. Caught in a maze of impersonal processes, with decisions made by computers instead of people, there are those who are denied credit because their data is “thin” after working abroad for a number of years or on becoming newly widowed or divorced, with no financial products in their name.
In addition, as the population ages, more will bump up against blanket age limits and the proportion of people with health conditions is likely to rise.
The numbers above for different groups are stark and measuring the scale of these access to financial services issues is difficult. Many people turned down for a product do not complain, so do not appear in complaints statistics, and firms do not keep data on how many would-be customers they turn away. Other consumers self-exclude, not bothering to apply because they expect to be turned down, often based on bad experiences in the past.
Since the government abolished Consumer Futures (originally the National Consumer Council) in 2014, the UK no longer has a statutory consumer body with a remit to research these kinds of issues and without proof of the scale of a problem, regulators, government and firms are often reluctant to act. The sad irony is that these consumers are shut out of the system and therefore cannot communicate their needs or wants to firms designing and delivering basic products like pensions and mortgages.
Access issues are especially important. The cradle-to-grave welfare state is a thing of the past, if it ever really existed. There was, at least, a belief that social housing, the NHS and state benefits would catch the homeless, the sick, the frail and the elderly, as part of a caring society.
These days, we are all expected to look out for our own financial well-being, sorting out our own safety nets, secure places to live and viable retirement. But being denied access to financial services means being shut out of modern life and put in a very vulnerable situation.
Author: Jonquil Lowe, Lecturer in Personal Finance, The Open University
The Real Estate Institute of Australia (REIA) has unleashed the hounds on Labor’s proposed reforms to negative gearing. The REIA’s campaign, Negative Gearing Affects Everyone, follows the lead of the Property Council, which describes the Australian housing market as a “house of cards”, with the REIA stressing how “fragile” the Australian economy is. You might be tempted to dismiss this as propaganda from people who exaggerate for a living, but evidence is mounting of instability close to the REIA’s home: the off-the-plan apartment sector.
An array of forces are converging to give the multi-unit house of cards a shove. Over the past couple of years apartment development has boomed. The Australian Bureau of Statistics shows building approvals for new flats, units and apartments reached a huge peak last year. It has stepped down in the most recent quarter, but is still very high.
You can see this development in the skylines of our cities, especially in Sydney, Melbourne, Brisbane and Canberra – and in the RLB Crane Index. RLB counts a total of almost 650 cranes engaged in construction in our capital cities, and says more than 80% of these are on residential projects.
This coming supply is reflected in CoreLogic’s projections for new units hitting the market. It estimates that sales for more than 92,000 new units will be settled in the next 12 months, only slightly less than last year’s total number of sales of new and established units. The year after, a further 139,000 new units sales are due to be settled, substantially more than total sales (new and established) last year.
But for all this supply, it appears there may be much less demand than anticipated, particularly from the foreign investors who did so much to stoketheboom. Evidence for this includes:
Over the last six months the Chinese government has tightened controls over currency exchange by its citizens. This has restricted their capacity to buy – and repay loans to buy – property in Australia and elsewhere. This in turn has led to…
Credit restrictions by Australian banks. Last month each of the Big Four banks restricted how much they’ll lend to foreign buyers (lower loan-to-valuation ratios), with Westpac withdrawing altogether. This month, Macquarie has pulled its horns in.
Foreign demand for new dwellings (as gauged by the NAB’s Quarterly Australian Residential Property Survey) was already down over the first quarter of the year, before the credit restrictions cut in. Now the media are reporting that Chinese demand for apartments has “fallen off dramatically”: Meriton says the number of Chinese buyers of its apartments halved in the last month.
As those cranes in the sky indicate, there’s a lot of people out there – foreign and local – who’ve paid deposits and entered into contracts to pay boom-era prices on completion of their units. When they go to the bank to borrow the balance, they may find that, between lower loan-to-valuation ratios and lower valuations, they are caught short. Some might make up the difference by selling another property, but many of those settlements projected by CoreLogic may not settle at all.
The result: deposits forfeited, unsold units dumped on the market – accelerating the bust – and possibly, at least for buyers who are actually in the jurisdiction, the threat of being sued by developers for the loss of the contracted higher price.
So what might policymakers do?
Faced with such a calamity, why won’t our politicians do something to shore up demand for all these newly constructed rental properties? Oh wait….
This is precisely what Labor’s proposed negative-gearing reform promises do, by allowing rental losses to be set against non-rental income only where the property is newly built. Under Treasurer Bowen, Australia’s dedicated army of negative gearers would be given new direction and purpose, switching from the established dwelling market into the new-built market deserted by foreign buyers. Furthermore, because no-one after the first purchaser can call a dwelling new (and hence get the same preferential treatment on their gearing), they may be inclined to hang on to their properties even as demand looks weak.
We should still expect such a reform to reduce total investor demand for housing, and hence reduce house prices overall. These are both good things. But it may also help cushion what might otherwise be a drastic and painful collapse in the new-build sector.
Both the REIA and the Coalition government talk about Australia’s “transitioning” economy. They should consider negative-gearing reform as a measure for transitioning out of our presently fragile, property-bubble-led economy.
Author: Chris Martin, Research Fellow, Housing Policy and Practice, UNSW Australia
Microfinance has been celebrated as a way to get money into the hands of poor people, and most famously women, so they can jump start small businesses. These tiny loans with minimal requirements to borrow have become a global phenomenon.
The 2005 United Nations “year of microcredit” was followed in 2006 by a Nobel Peace Price to the Grameen Bank in Bangladesh. In the decade since, microcredit has grown from a visionary call for women’s empowerment to a mainstay of economic development initiatives. Increasingly it has even moved into mainstream commercial banking. There seems to be a general consensus that for entrepreneurship, you simply add credit and stir.
It’s estimated that there are about 90 million active borrowers in microfinance institutions (MFIs) worldwide, and the sector granted US$81.5 billion in loans in 2012.
Meanwhile, MFIs have grown into emerging areas such as mobile banking, insurance and savings, education loans, and digital financial services. As the suite of financial services and products has expanded, so has the wider development mission. The notion of providing credit to poor women has evolved into the bigger idea of building a robust financial system that can serve poor and low income communities.
Like the microcredit movement that it grew out of, the push for “financial inclusion” challenges the current state of affairs. Currently, using money is by far the most expensive for people with the least money to spare. There’s a need to fundamentally rethink financial services along more inclusive lines.
What could be wrong with expanding financial services to include the billions of people currently left out of the traditional banking sector?
More inclusive and democratic forms of banking surely bring financial services to people and communities that had been excluded from key markets. But academic research and policy analysts both sound some notes of caution. Economists such as Charlotte Wagner have studied the growth of microfinance and found it to be part of the same credit glut experienced in the traditional banking sector in the mid-2000s. It could be susceptible to the same boom and bust cycles.
Has the rapid expansion of credit left the sector vulnerable to an unstable global credit market? Disturbing stories of borrower suicides in India linked to over-indebtedness would point in that direction. A volatile market and increasing pressures on debt collection might be some unintended outcomes of a global push for financial inclusion.
My research on the hidden costs of microfinance began with two years of on-the-ground anthropological fieldwork on the culture of credit in Latin America. Behind the numbers, what was the experience of living on credit for the families, neighbourhoods, and communities enrolled in these development projects?
What I ultimately found was that women navigated an economic world that was awash in credit. In fact, many people in the financial services industry in Paraguay, from microcredit borrowers all the way up to a credit scoring executive, told me that when it came to credit they were “bicycling.” The common saying implied that they spun the pedals by paying off one loan with the next.
Turning the wheels of the “credit bicycle” meant constantly seeking out new opportunities to borrow. In practice, these debts were from development organisations, consumer credit, local businesses, savings and loan cooperatives, finance companies, and informal loans from friends and family. And they were directed toward a mix of small business ventures, consumption, and income smoothing. Microcredit, with its mission of financial inclusion and very lenient requirements for things like credit history, income, or collateral requirements, ultimately supported exactly this sort of “bicycling” credit.
Unintended consequences
The research suggests the “democratisation of finance” for micro-entrepreneurship could go the same way as that of the mortgage market, particularly in the United States: subprime lending.
The social justice impulse to promote access to banking services, especially to women, is a good one. But it is not that dissimilar to the social justice impulse to promote home ownership for people who had previously been excluded from the mortgage market. In the bigger picture, this also means the financial sector is increasingly targeting very vulnerable communities, whether poor women or low-income homeowners, as a source of profit.
The repayment rate on microcredit loans has been very high, up to 98%. In Paraguay, this was often because women feared losing this crucial lifeline and falling off the “credit bicycle.” Most of the borrowers I encountered would no more be able to do without debt than many in the developed world would be able to cut up their credit cards.
Like the mortgage market, though, perhaps one crucial element of financial inclusion will be to ask some hard questions of the protections needed as loans grow. We ask women borrowers to rely on one another and on their families to make their loan payments. They must look inward to their social networks for a safety net. As subprime lending reshapes their economic lives and livelihoods, we might also question how long those communities might be expected to shoulder the risks alone.
Author: Caroline Schuster, Lecturer, School of Archaeology and Anthropology, Australian National University
The Government’s Pre-election Fiscal Outlook (PEFO) was a non-event in one sense but it did underscore two important lessons, the absurdity of a 10 year forecast and the need for a stronger Parliamentary Budget Office.
Coming only 17 days after the 2016-17 budget, PEFO essentially confirmed the budget numbers. It would have been worrying if it had not done so, considering the PEFO comes from the same Treasury and Department of Finance that produced the budget.
The first important lesson we should draw from the budget and PEFO is the absurdity of costing spending or tax changes over a 10 year period. We are told for instance that the budget cut to the company tax rate to 25% will cost A$48.2 billion over 10 years, while Treasury noted that “as with all projections over 10 years these costings have considerable uncertainty attached to them”. Then why produce a number to one decimal point? It conveys an entirely unjustified degree of precision.
This year’s Federal Budget Paper No 1, Statement 7 is a sobering read. Chart 5, see below, shows the forecast errors for tax receipts, not 10 years out, but one year out. It compares the budget forecast for the forthcoming year with the actual outcome for that year.
In every one of the six years since 2010 the forecasts have been wrong by large margins – but worse, the errors are all in the same direction, that is, receipts have been less than forecast.
This forecasting record calls into serious question Treasury’s stubborn adherence to assumptions that repeatedly turn out to be wrong. The biggest single source of error is company tax receipts which were overestimated last year by A$3.5 billion, which makes a projected number like A$48.2billion over not one but 10 years an exercise in pure fiction, and to give the number to a decimal point is silly.
The budget forecasts (which apply to the next four years) as distinct from the projections (which extend for a further 6 years) come with “confidence intervals”. For example Treasury can only be 70% confident that tax receipts will turn out to be equal to the budget figure plus or minus A$30 billion (1.8% of GDP) by 2017-18, implying a 30% chance that the budget figure could be wrong by more than A$30 billion. The 90% confidence interval is wider – plus or minus A$50 billion (2.9% of GDP).
These are wide margins considering we are talking about outcomes only three or four years away. These margins get wider the further into the future. So 10 years out we really have no idea.
Perhaps the more important lesson from the budget and PEFO outcomes is the need to elevate the role of the Parliamentary Budget Office (PBO). It needs more teeth.
Its current role is “to inform the Parliament by providing independent and non-partisan analysis of the budget cycle, fiscal policy and the financial implications of proposals.” This needs strengthening.
Rather than just providing independent analysis of the budget the PBO should independently produce fiscal rules aimed at fiscal sustainability, ensuring that government debt is not set to rise inexorably under current settings and that our AAA credit rating is maintained. A government that breaches the fiscal rules should be called out by the PBO and suffer public censure.
The PBO should take account of the likelihood of the Senate passing legislation, of political compromises, of credit rating changes, and of international economic risks arising for example from commodity prices and China’s economy. The fiscal councils in Belgium, Denmark and Sweden operate rather like this and the evidence suggests that they have improved fiscal discipline by increasing the political costs on governments for lack of discipline.
We could go further and allow the PBO to operate like Australia’s independent Reserve Bank which controls the key monetary policy instrument and sets monetary policy independent of government. In that case the PBO would provide the government with a maximum spending limit and a deficit limit, consistent with fiscal targets.
The government would control the mix of spending and taxation consistent with these fiscal targets. Admittedly this is extreme and has not been tried in other countries, but with increasing government indebtedness around the world perhaps it should be.
The federal government’s debt has risen from minus A$45 billion (a net asset position) in 2007-8 to A$285 billion in 2015-16 (or 17.3% of GDP). The global financial crisis and subsequent drop in commodity prices had a lot to do with this.
But now that it is clear the economic cycle is not going to repair the budget, the government should tighten its belt to ensure that future generations are not picking up the tab. This is not currently happening – the budget forecasts net debt in four years’ time to be in fact higher than now, at 17.8% of GDP, and with no reduction in spending as a share of GDP.
A beefed-up PBO, acting as an independent fiscal agency, would call out the government on such a lack of fiscal discipline.
Author: Ross Guest, Professor of Economics and National Senior Teaching Fellow, Griffith University
When Prime Minister Malcolm Turnbull attempted to defend negative gearing by explaining that it had allowed a baby to enter the housing market, he triggered a debate still raging on the facts of the issue.
The minutiae of negative gearing, once largely confined to discussion among policy experts, became mainstream news.
The Project’s Waleed Aly joined in, giving a compelling analysis of the need for tax reform for a more equitable Australia. Cutting to the chase, Waleed described a situation where “the cost of the average house is roughly 4.3 times household income.”
https://youtu.be/sa2XO5Jn2K0
Waleed Aly explains why negative gearing should be abolished.
Aly’s well-executed explanation reminds us that making sense of policy requires motivation, economic and financial knowledge, and a range of capabilities.
Aly demonstrates this motivation in an accessible way. He shows that he has read and watched others’ analysis of economic issues. He is curious and asks questions, including “What does this mean for me?”. He can apply financial mathematics. He demonstrates critical thinking about political spin. He shows skillful communication about his experiences and views. Further, he demonstrates that he is ethically oriented to a more equitable Australia.
Most of us know changes being made to tax and super are important. But let’s face it, this stuff makes our eyes glaze over. And sometimes our financial literacy is tested.
The role of financial literacy
In Australia, low socioeconomic status and low financial literacy tend to go hand in hand – among both adults and teenagers. Those who struggle with financial literacy surveys are typically cast as needing more financial knowledge.
But having a limited level of education doesn’t necessarily mean someone has a low financial literacy. Take father of two Duncan Storrar who appeared on Q&A last week and introduced himself as having “a disability and a low education”. Storrar questioned the government’s move to lift the upper end of the 32.5 cent tax bracket from $80,000 to $87,000. But when Innes Willox from the Australian Industry Group said those on the minimum wage don’t pay much tax, Storrar quickly replied, “I pay tax every time I go to the supermarket”.
Behavioural economists tell us that financial problem-solving and decision-making may depend as much on values, expectations, emotions and notions of control and confidence about money than knowledge. This means that your family and socioeconomic background is powerfully influential and teaching and learning about money can be values-laden. So it doesn’t matter how old those needing to improve their financial literacy are – crafting relevant and meaningful financial literacy lessons is by no means easy.
So, what is the best approach?
The answer depends on who you ask. Financial experts generally suggest teaching responsible money management, including budgeting and saving. Going back to Malcolm Turnbull and Waleed Aly, Turnbull wants us to believe that with the right parents, financial advice and greater discipline, we might all have not one, but two or more properties. Akin to the weight-loss movement, this plays on our emotional attachment to a particular dream and provides an incentive to do more to keep track of our money.
By contrast, educational experts tend to see things differently. Aly seems to have knowledge and capabilities that are desirable, teachable, and transferable to a range of “real world” problems. He embodies what it means to be financially literate to the extent that he brings a range of capabilities to making sense of his everyday financial reality within a complex financial system.
What should be taught in schools
Australia’s National Financial Literacy Strategy, led by the Australian Securities and Investments Commission, identifies formal education as a priority.
If Australian schooling is to achieve its goals of promoting equity and active and informed citizenship, there needs to be a rethink of what it means to be financially literate. This means bringing social justice to the conversation and shifting the emphasis from “responsibility” to “capability”.
Consider this starting point for a lesson:
Jason and Jane are twins. Both start working at McDonald’s at the age of 15. Both graduate from University and pursue professional careers. While their careers progress at a similar rate, Jason’s average annual income of $100,000 is 10% higher than Jane’s. Jane’s career is interrupted by 3 x 12-month periods of maternity leave and a total of 10 years working only 3 days per week. Jason works full-time continuously throughout his career. Both retire at the age of 65. Evaluate the financial decisions Jane and Jason must make, and the impact on their lives.
This approach has been researched – we know it works. Looking at the Australian Curriculum, Economics & Business and Mathematics are important learning areas to apply to this problem-based lesson. But it is the seven general capabilities that are central. These capabilities include: literacy; numeracy; information and communication technology; critical and creative thinking; personal and social capability; ethical understanding; and intercultural understanding.
The key to preparing students for life beyond school is identifying “real world” financial problems and teaching through issues, as opposed to topics.
For example, a good teacher might plan a provocative lesson about the information gap between a bank or insurer and the customer by discussing the CommInsure life insurance scandal.
Author: Carly Sawatzki, Lecturer , Monash University
For economists and others who ‘grew up’ being challenged to achieve low and stable inflation against the background of high and volatile inflation rates that emerged in Western countries in the 1970s (and persisted in Australia through the 1980s), the possibility inflation could be ‘too low’ can seem like something from another universe.
The Reserve Bank of Australia’s 2-3% inflation target was more-or-less unilaterally promulgated by Bernie Fraser (who was RBA Governor from 1989 until 2006).
In a speech just after the 1993 election (at which the Liberal Opposition had advocated the introduction of a 0-2% inflation target, similar to that which had been adopted in New Zealand in 1989), Fraser suggested that:
“If the rate of inflation in underlying terms could be held to an average of 2-3% over a period of years, that would be a good outcome. Such a rate would be unlikely to materially affect business and consumer decisions, and it would avoid the unnecessary costs entailed in pursuing a lower rate.”
The target was formally embodied in a Statement on the Conduct of Monetary Policy agreed between newly-installed Treasurer Peter Costello and newly-appointed RBA Governor Ian Macfarlane shortly after the 1996 election, and has been re-iterated after each change of government and upon each appointment of a new RBA Governor ever since.
Australia’s approach to inflation targeting differs from that of most other countries which have inflation targets in two important respects. First, it does not stem from a government directive, nor is it enshrined in legislation. As former Governor Ian Macfarlane has said, “the government didn’t introduce it, we introduced it”.
The Reserve Bank does not have to “explain itself” to politicians if it “misses” its target for some reason. Second, the target is intentionally and explicitly flexible. It is expressed as a range, to be achieved “on average” and “over the course of the business cycle” (a term which is not anywhere defined), rather than at all times and in all places, as it were.
This means that the Reserve Bank can “tolerate” inflation being either above or below the target for a temporary period if it has good reason to believe that the deviation is only temporary, or is the result of some one-off factor whose influence will soon pass, without needing to take monetary policy actions to push it back into the target range more quickly but which would, in the RBA’s judgement, not otherwise be necessary.
This “flexible inflation targeting regime” has served Australia well over the past two-and-a-bit decades. The target is widely perceived to be “credible” – that is, it is widely recognised and understood that the Reserve Bank will do what it needs to do in order to ensure that it is achieved (as it demonstrated, for example, in 1994 and in 2007).
As a result, it has served to “anchor” inflationary expectations – that is, to give participants in the economy (businesses, consumers, union officials, governments and others) a sound basis for expecting that inflation will average somewhere between 2 and 3% over the medium-to-longer term – as it was intended to do.
And it has allowed the RBA to keep interest rates more stable than would have been the case if it had been required to chase after inflation on each and every occasion on which it temporarily departed from the target range.
With the annual “headline” rate of inflation having been below the bottom end of the 2-3% target range since the December quarter of 2014, and more recently the annual “underlying” inflation rate also having dropped below 2%, some have suggested that the inflation target should itself be lowered.
This would allow the central bank more room to accommodate unusually low inflation without having to cut rates to levels which might risk triggering unsustainable rates of credit growth and/or an asset price bubble.
Ironically, the opposite proposition was put during the resources boom of 2010-12, when some suggested that the RBA should increase its inflation target so as not to have to raise interest rates as much in the face of the inflationary pressures which it was feared that boom might engender.
The RBA resisted such calls on that occasion, and should do so on this. As it is formulated, the RBA’s flexible inflation target gives it latitude to determine how dogmatic it needs to be in pursuit of “low and stable” inflation.
If it were to change its target every time it appeared as though inflation might be either above or below the target range for an extended period, the target would eventually lose whatever role it has as an “anchor” for inflation expectations, increasing the chance that inflation would – as a result of the well-documented propensity of inflation expectations to become self-fulfilling – remain above or below the target for even longer, and perhaps by even wider margins.
Australia’s inflation targeting regime has served the country well, and the challenges it faces at this time are not so great as to warrant altering it.
Author: Saul Eslake, Vice-Chancellor’s Fellow, University of Tasmania
A memo on the subject of housing taxation from the Reserve Bank of Australia (RBA) is stirring up debate on proposed changes to negative gearing and capital gains tax in the election campaign. The memo, dated December 9 2014, does counter the government’s claim that changes to negative gearing will have an adverse effect on housing prices, although this was never its intended purpose.
The memo was in response to the report from the Financial System Inquiry two weeks earlier. The inquiry noted that reducing capital gains tax concessions would “lead to a more efficient allocation of funding in the economy,” that “the tax treatment of investor housing…tends to encourage leveraged and speculative investment,” and that “housing is a potential source of systemic risk for the financial system and the economy”.
The RBA is usually reluctant to comment on areas of government policy outside its remit and hasn’t expressed any views on whether changes are needed to the long-standing tax treatment of housing investment. However, in response to a Productivity Commission inquiry 12 years ago, the RBA pointed out that:
“…taxation arrangements in Australia are more favourable to investors in residential property than are the arrangements in other countries.”
It also went on to note that a higher share of Australian taxpayers are attracted to property investment to lighten their tax burden and reducing investor demand would allow for more demand from first home buyers, without adding to the overall pressure on demand and prices. The RBA submission suggested this could also lead to a more stable housing market.
At that time, housing investors accounted for just over 45% of all lending by Australian financial institutions. In 1999 this was less than 32%, when the Howard government amended the tax treatment of capital gains in a way that made it more generous to investors (in property and other assets).
After falling back to around 36% in the aftermath of the global financial crisis, the share of property loans taken out by investors rebounded to more than 50% in the first half of 2015. The Australian Prudential Regulatory Authority (APRA) has since required banks to tighten their lending standards for property investment loans, now the share of new housing loans going to investors has fallen back to about 45%.
The key point to note here is that the changes enforced by APRA to banks’ lending criteria have also had the effect of dampening investor demand, as Labor’s current policy also intends, without any obvious adverse effects on property prices.
The government’s strict enforcement of foreign investment regulations, designed to prevent foreigners from purchasing established properties (other than in limited circumstances), and the cutting of grants to first-time buyers of established properties while boosting grants to first-time buyers of new dwellings at a state level, have both failed to dampen investor demand for property.
In other words, governments are trying with these policies to reduce demand for the purchase of established dwellings (90% of borrowing by Australian property investors is for the purchase of established dwellings) while encouraging the demand, and therefore building of, new properties. This is exactly what the Opposition’s proposed changes to negative gearing and the capital gains tax discount seek to do.
Labor is trying to make it less attractive for investors to buy an established property after 1 July 2017. As a result, the prices of established dwellings should go up at a slower rate than it would otherwise – and from the standpoint of would-be home-buyers, this is a good thing.
However, the Opposition proposes to “grandfather” existing negatively-geared investors from these changes. This means anyone who has a negatively geared property investment as of 30 June 2017 will still be able to offset the excess of their interest costs over their net rental income against their other taxable income. So there is no reason to expect that investors will seek to sell their investments en masse and that prices of existing properties will fall any more than they have done as a result of the other government measures.
And this is precisely what the memo from the RBA notes:
“only if changes were not grandfathered” would there be a risk of “large scale sale of negatively geared properties.”
The RBA note also raises the possibility that changes to negative gearing could prompt a “potential increase in rents” – a point which the Coalition has been as quick to seize upon. Presumably this concern reflects an assumption that if changes were to be made to existing negative gearing arrangements, those changes would apply to new properties as well as established ones (since the Financial System Inquiry whose recommendations prompted this staff memo didn’t make any distinction between the two).
The Opposition’s policy is to keep existing negative gearing arrangements for investors in new dwellings. There is a risk that it could end up inflating builders’ profit margins, rather than boosting the supply of new housing.
However, to the extent that it does the latter, there is less reason to expect rents to rise. This is because under the Opposition’s policy more would-be home-buyers could fulfil their aspirations. It would reduce the competition they face from investors who negatively gear and this would decrease the demand for rental housing.
The Reserve Bank hasn’t explicitly supported Labor’s negative gearing policy. But it does appear to have rebutted one of the government’s principal arguments against it.
Author: Saul Eslake, Vice-Chancellor’s Fellow, University of Tasmania
The price gap between houses and apartments in many Australian cities is closing as property investors exhibit a significant degree of herding behaviour, according to new research.
The research comes amid speculation that Australia is in a housing bubble. Herding behaviour is leading to excessive borrowing, further fuelling apartment prices, particularly in Sydney.
A major cause of the sub-prime crisis in the US was a herd mentality, in which home buyers were influenced by purchasing behaviour of others. More recently a widely publicised 2015 report by global fund manager PIMCO suggested that low interest rates and rising house prices in Australia were driving similar behaviour.
We examined whether there was formal evidence of a herd mentality in Australian metropolitan property markets. To do so, we looked at the dynamic interaction between house prices and apartment prices in Australian capital cities using monthly CoreLogic RP Data from December 1995 to June 2015.
Figure 1. Monthly house and Apartment prices (December 1995- June 2015) Note: Green dotted lines show the narrowing of the pairs over time.CoreLogic RP Data
Figure 1 shows house and apartment prices exhibit a strong degree of co-movement and both prices tend to deviate from each other quite often. Nevertheless, every now and then the price gap has narrowed.
Except for Canberra, in all cities the narrowing takes place after a long period of widening. There are at least two reasons why there is a long-run relationship between house and apartment prices. First, houses and apartments are considered as substitutable investments. Second, negative gearing and capital gains provisions encourage people to borrow against the equity in their home to purchase an investment property, which is typically an apartment. When the price of the family home increases, this boosts demand for apartments, pushing up their price as well.
We found that in some cities such as Sydney, investors can equally profit by purchasing apartments because rising house prices eventually push up apartment prices and vice versa.
We found house prices significantly affect apartment prices across all cities. But in only four cities (Adelaide, Melbourne, Perth and Sydney) apartment and house prices influenced each other equally. However, when apartment prices are on the rise (i.e. the market is bullish), the positive impact of house prices on apartment prices is substantially larger. This implies that investors exhibit a significant degree of herding behaviour. Such evidence of herd mentality is highest in Sydney and lowest in Darwin.
Our finding for Sydney is consistent with a widely accepted view by RBA officials who argue that prices have grown too fast and there is a housing bubble threatening to burst. Vernon Smith, who won the 2002 Nobel Prize in Economics and visited Australia in July 2015, also recently said Sydney house prices are in a bubble.
There are various ways in which this herd mentality might be reined in, including adjusting interest rates, tightening lending criteria, changing negative gearing and reforms to self-managed superannuation. Some of these initiatives have already been introduced.
Although Australia has partially recognised this issue by prohibiting the purchase of established properties by foreign investors, there still remains several loopholes that go undetected, making housing extremely unaffordable for young Australians. This has increased intergenerational inequality between millennials and baby boomers that policy makers must be brave enough to make hard decisions about based on evidence rather than election outcomes.
Authors: Abbas Valadkhani, Professor of Economics, Swinburne University of Technology; Russell Smyth, Professor, Department of Economics, Monash Business School, Monash University
In his budget reply speech this week, Opposition leader Bill Shorten said Labor had “very grave concerns about retrospective changes” to superannuation being proposed by the government. The superannuation industry has been even more vociferous. But labelling the changes as “retrospective” in this case is a furphy.
For a decade, some older savers have benefited from superannuation tax breaks that did little to help younger generations. Understandably, they want to keep receiving these benefits. But they are wrong to claim the government’s proposed superannuation changes are retrospective simply because they adversely affect the future returns on their savings.
“Retrospectivity”, a legal concept, applies if government changes the legal consequences of things that happened in the past.
The Commonwealth government proposes two changes to superannuation rules in the 2016 budget. First, funds in excess of A$1.6 million in pension phase (when the fund holder pays no tax on earnings) will have to be moved into a separate account that pays 15% tax on earnings. In effect, retirees will pay no tax on the earnings of assets up to $1.6 million, and 15% tax on earnings after that.
Second, the budget proposes a new lifetime limit of A$500,000 on post-tax contributions to super. This includes any contributions made between 2007 (when reliable records begin) and budget night. If someone has already contributed more than this, there will be no penalty, but they will not be able to contribute any more from their post tax income.
The rationale for both changes is that they align superannuation more closely with its purpose of supplementing or replacing the Age Pension. A person with $1.6 million in a superannuation account, or a person contributing more than half a million from post tax income (in addition to pre-tax contributions), is going to be well over the asset limit for a part Age Pension ($805,000 for a couple home-owner).
The objection is that these changes retrospectively affect superannuation investments made in the past. But lots of changes affect investments made in the past, and no-one suggests they are retrospective. If I bought shares in a company yesterday, I expect that the future earnings on these assets will be subject to my marginal income tax rate. But if my income tax rates change, I would not expect that the old tax rate to be grandfathered to apply to all my future earnings.
This is the appropriate analogy for proposed changes to the earnings of superannuation accounts in excess of $1.6 million. The mere fact that no tax was paid on earnings in the past does not imply that earnings in the future are entitled to be tax free.
The retrospectivity argument is even weaker for the new cap on post-tax contributions. The only constraint is on additional contributions in the future. True, this is based on the amount that has already been contributed, but no adverse consequence flows from historic contributions; the change merely limits future contributions. To draw another analogy, it is not retrospective to change the asset test for the Age Pension merely because assets accumulated in the past are now taken into account for assessing future Age Pension payments.
Alternatively, we can analyse this problem using ethical concepts that are reflected in the legal doctrine of “estoppel”. This applies if a person reasonably relies on a promise of another party, and because of that reliance is injured or damaged.
The proposed changes do not fall foul of this doctrine.
Those who were induced to put more money into super would be a long way in front even if they had paid 15% tax on all earnings in retirement. Most contributions to superannuation are made from pre-tax earnings, and only taxed at 15%. Even those on very high incomes who pay tax of 30% on their contributions are still getting a discount of more than 15 per cent compared to post-tax savings. Once in the super fund, the earnings on those contributions are only taxed at 15% rather than at marginal income tax rates. The only people who could possibly have lost money contributing more to superannuation are those with taxable incomes less than A$19,000 a year – below the income tax-free threshold. If any of them have accumulated more than $1.6 million in superannuation, the ATO should probably be asking them some questions.
Superannuation tax concessions have been absurdly generous to older people on high incomes for over a decade. They have not served the purposes of the system. They are one of the major reasons why households over the age of 65 (unlike households aged between 25 and 64) are paying less income tax in real terms today than they did 20 years ago, even though their workforce participation rates and real wages have jumped. Misguided claims about retrospectivity should not be used as cover so that this older generation continues to gain unjustifiable benefits that will now be denied to younger generations.
Author: John Daley , Chief Executive Officer, Grattan Institute
