Many older Australians are living in larger dwellings than they need after their adult children leave the family home. The 2011-12 ABS Survey of Income and Housing shows households aged 55 and over are more than twice as likely to have three or more spare bedrooms in their home than those aged under 55.
However a report released by the Productivity Commission today found most people are happy staying in their family home, despite a common perception that such homes are too big for them.
For some older home owners, this may well represent a positive choice driven by lifestyle reasons or because of an attachment to the family home. But for others, the decision to remain in place may be forced by barriers that prevent them from downsizing into a smaller or cheaper property.
The Productivity Commission says there is a general lack of affordable downsizing options for older Australians, due in large part to the red tape and inconsistencies within state and territory land planning regimes. Older people who wish to downsize also face financial barriers inherent in the tax-transfer system.
There is an opportunity to promote more efficient use of housing stock by relaxing the disincentives to downsizing among seniors, and to reap something of a “double dividend” from so doing. This would free up housing space for younger families. And older home owners would be able to release some equity from their home by downsizing into a cheaper property. This would in turn help supplement incomes in retirement.
A recent report on population ageing by the Bankwest Curtin Economics Centre found downsizing activity to be quite limited among older Australian home owners. During 2001-13, the incidence of moves among home owners aged 45 and over was just 5%. Among those who did sell their family home only to buy a new one, less than half moved into cheaper dwellings.
Financial barriers to downsizing
There is general consensus that the tax-transfer treatment of downsizing proceeds blunts incentives for seniors to downsize. Firstly, net proceeds from downsizing are subject to means tests. Secondly, stamp duty has to be paid on new home purchases.
A comparison across the five most populous states in Australia show the impact stamp duty has on the decision to downsize.
From 2001 to 2013, downsizing accounted for 28% of all property moves in Western Australia by homeowners aged 45 and over. Equivalent downsizing rates were substantially higher in other states – 36% in Victoria and more than 40% in NSW. At the same time, the average incidence of stamp duty on housing equity released through downsizing was highest in WA at 25%. This compares to just 15% in Victoria and 12% in NSW.
Median stamp duty as a percentage of median housing equity released through downsizing by owners aged 45 years and over, by State, 2001-2013
However, a closer look reveals that jurisdictional differences in stamp duty parameters are not the cause of the relatively high stamp duty burden in WA. The fact is that older West Australians tend to downsize into homes of higher value than older home owners in other states. This finding is not surprising given the year-on-year spike in house prices that occurred in WA during the last decade’s resource boom. A growing lack of affordability in local housing markets is eating into expected returns from downsizing.
From piecemeal to meaningful tax reforms
Some recent attempts have been made to improve downsizing incentives, but the measures have been rather piecemeal. For instance, the 2013 downsizing pilot program proposed by the Federal government attracted criticism for its restrictive eligibility conditions. Stamp duty concessions for downsizing have been implemented in some states and territories. But they simply do not go far enough to overcome the combined financial and emotional costs of moving out of a home in which families have been raised, and memories built.
Economists have long argued for the total abolition of stamp duty. It is often recommended that this should be accompanied by the levying of a broad-based land tax. This two-pronged reform would not only cushion revenue incomes for the State but also promote affordability as land tax is capitalised into lower land prices. Such reform measures are of course feasible. But they are conditional on both tiers of government being willing to share the cost of transitional arrangements for existing home owners.
However, what is often overlooked are the structural problems inherent in the general tax-transfer treatment of housing assets. The exclusion of the primary home from welfare means tests has encouraged extensive accumulation of wealth in housing assets by home owners. Not only is the entire value of the family home exempt from assets testing, home owners enjoy a wider range and higher levels of housing subsidies than renters, including but not limited to the First Home Owner Grant, land tax exemption, capital gains tax exemption and non-taxation of imputed rent. Put bluntly, current tax-transfer settings simply do not offer any financial incentives for seniors to divest their housing wealth through downsizing or any other means.
The preferential tax-transfer treatment of home ownership has also helped fuel house prices to historically high levels, making it difficult for seniors to find affordable properties to downsize into in their local area. If tax reform is to be successful in encouraging downsizing among seniors, it will have to deal with an entrenched structural problem that has contributed to a long-run inflationary bias in housing markets.
The prospect that the central banks of the US and the eurozone will soon make opposing moves on policy rates has allowed financial markets once again to demonstrate their neuroses. Some market participants are expecting exchange rate turmoil – but while this may always make good copy, it does not always follow from good analysis.
We saw this kind of frenzied response over the summer, when a couple of small changes in the Chinese renminbi exchange rate and continuing problems in Greece (an economy accounting for less than 2% of eurozone GDP), seemed to be capable of stopping rational analysis in its tracks.
The raison d’etre for financial markets is rather simple: they price the ongoing story of risk and ensure that assets consequently give an appropriate pay-off. Now, if markets cannot manage to price risk very well, then they tend to claim that uncertainty – by which we mean things we do not understand very well – has beaten them. For highly paid, intelligent individuals that is not a very good answer, particularly when it is used as an excuse to ask for extensions of the ultra-low interest rates that have made the whole tiresome business of capitalism so much simpler. More worryingly, of course, it means that something quite fundamental has gone wrong.
Accounting for changes
Indeed, the prospect that the US Federal Reserve will raise rates, as might the Bank of England next year, should be a clear signal for rejoicing rather than dread. The normalisation of interest rates is a sign that we are returning to normal times and is not a problem per se.
Equally, normalisation does not mean that the crisis is over or that there may not be troubles ahead. But it does indicate that we are probably past the worst of the ills stemming from the crisis of 2007-8. That is surely a good thing.
So why is the European Central Bank expected to cut rates again, or even extend the scale of QE, when its American equivalent is heading in the other direction?
Well, in the UK and the US, rates have been in the doldrums since 2008-9 when extensive quantitative easing (QE) policies were also started. However, in the eurozone, even though there has been extensive provision of liquidity, peripheral countries such as Portugal, Spain, Ireland and Greece suffered from the twin reinforcing problems of sovereign debt crises and bank fragility.
Eurozone QE was only started in January this year, rather late, and in a monetary union that lacks an appropriate degree of cross country fiscal insurance. Look, for example, at the extent to which the rest of the UK has been able to support Scotland following the collapse in oil prices. And so, given lacklustre average growth in the eurozone, it is hardly surprising that interest rate policy is not quite ready to normalise and indeed may need to be somewhat more supportive.
Same journey, different car
The key to understanding central banks is that they do not wish to jeopardise hard-won reputations for price stability. This means that they will use policy rates, and whatever influence they have on other market interest rates, to ensure that domestic inflation and longer term expectations for inflation continue to be consistent with price stability. Any divergence in policy rates between the US and Europe is simply like saying they are in different places on the map but still are trying to get to the same point.
Let me illustrate with a simple example. If Country A and Country B both suffer a common shock and have a similar economic structure, then policy rates will tend to move together and the economies will plot a similar path back to full employment.
But if Country A is booming and Country B is undergoing retrenchment, then the common aims will imply quite different responses. Country A will raise rates. This makes borrowing more expensive and saving more lucrative which will bear down on aggregate demand through the usual channels of consumption and investment. Country B will cut rates or, if they are already close to zero, increase quantitative easing in the hope of stimulating activity.
A key part of the transmission mechanism of these interest rates changes will be the exchange rate. The expectations of a higher interest rate in Country A, will lead to an appreciation in its exchange rate relative to Country B and this will further act to suppress demand in Country A. Also, rather handily, it will stimulate exports from Country B which will now be cheaper. The jump in the exchange rate is exactly what both countries need to help them get to their destination. The exchange rate thus allows risk to be shared, thankfully.
Off the charts
Euro-Dollar Swap Spread and Spot Exchange Rate 2000-2015.Source: Macrobond
So does divergence matter at all? Not if it simply promotes an orderly adjustment in the exchange rate. The chart above shows a plot of the daily euro-dollar exchange rate (blue) against the euro-US spread in two-year swap rates (red). The difference in short term market interest rates such as swaps sounds complicated but is simply a measure of market participant’s expected costs of borrowing in euros as opposed to dollars. If the swap rate spread is high, it means that we expect US rates to be higher than European rates on average over two years.
And as we might reasonably expect, the exchange rate, to a significant degree, reflects changes in these relative interest rates, particularly since 2008. And so it is simply a function of the relative stance of monetary policy and part of the expected adjustment mechanism.
For example, we can see that in both 2008-2009 and also in 2010-2011 the rise in the dollar was associated with a fall in the euro-dollar swap rate spread. Moreover, the two-year appreciation in the dollar since 2013 has been associated with a 100 basis point fall in the euro two-year swap rate versus the dollar two-year swap rate. To the extent that monetary policy divergence simply promotes these kinds of stabilising changes in the euro-dollar exchange rate, then bring it on; it is precisely what both economies need.
Author: Jagjit Chadha, Professor of Economics, University of Kent
If digital disruptors like crowd-sourced equity funding and peer-to-peer lending platforms are going to transform the finance sector, they need to be regulated. If they are going to create permanent positive change, they need to be regulated intelligently.
But so far, the ability of regulators and industry to agree on the rules has been hampered by a significant knowledge gap: there is no accurate, up-to-date information about the size, scale and scope of the rapidly growing online alternative finance sector in our region.
The University of Sydney Business School has joined forces with the United Kingdom’s University of Cambridge and Tsinghua University in China, to conduct the first comprehensive survey of the rapidly expanding alternative finance sector in China and across the rest of the Asia-Pacific.
Building on a successful 2015 benchmarking survey of the UK and Europe, the Asia-Pacific survey will run through to mid December 2015. By early 2016, we will have aggregate information about the various types of online platforms, the overall size and recent growth of the alternative finance sectors in Australia, New Zealand, Singapore, China and other Asia-Pacific neighbours.
Why is aggregate data on crowd-sourced and peer-to-peer finance so critical? Uninformed regulation can indeed be harmful — so why regulate at all? Direct connection between lenders and borrowers, or donors and causes, is part of the attraction of alternative finance, and that’s all between consenting adults after all. But it’s the “peer-to-peer” feature of these markets that calls for intelligent regulation.
Naïve ideology sees all regulation as anathema to free markets. In reality, most markets can’t function without it. Efficient markets depend on reliable information about product quality being shared between buyers and sellers, as Nobel prize winner George Akerlof demonstrated in his analysis of the used car market – his famous work on the “market for lemons”.
If buyers can’t tell whether they are buying a good car or a lemon they will never pay what a good car is worth. Owners of good cars will not offer their cars for sale and eventually only lemons will be left. Markets with this unequal information problem are likely to collapse without minimum quality guarantees.
In crowd-funded and peer-to-peer finance markets, the borrower knows much more about their ability to repay than the lender does. Minimum credit worthiness standards for borrowers, some limitations on risk exposure for unsophisticated lenders, and effective disclosures are needed for the survival of these platforms.
Take peer-to-peer lending for example. In conventional lending markets an intermediary like a bank transforms the deposits of lenders into loans for borrowers. Intermediation turns one person’s bank deposit into another person’s loan but no individual depositor cops a direct hit if a particular borrower defaults; the intermediary bears this risk. Of course, banks charge for the service of disconnecting lenders from the risk of individual borrowers.
This charge partly accounts for the (at least 10 percentage points) difference between term deposit rates and personal loan rates.
Peer-to-peer lending uses a direct connection between lenders and borrowers. This allows the platform to shrink the difference between lending and borrowing rates. Someone wanting a $5,000 loan for a holiday might register with a peer to peer platform. If they default on their repayments, whoever lent them the money bears the loss. While the average default rate across all loans on a peer-to-peer lending platform in normal times might be low – say less than 3% – the actual outcome for each lender depends on the specific borrowers they lend to and economic conditions at the time.
Without some minimum guarantees and lender protections, interest rates and charges are likely to rise as poor quality borrowers (lemons) drive out good quality borrowers, and the market will collapse. Similarly, the crowd-sourced equity platforms that can enable brilliant and highly profitable new ideas (so-called “unicorns”) to find capital depend on regulatory protection for unsophisticated investors. Stability, sustainability and trust are needed so we can all benefit from the accessibility and efficiency of this digital disruption.
Most alternative finance providers now operating in Australia are well aware of the need for sustainable business practice. Peer-to-peer lenders, for example, check the credit worthiness of borrowers in conventional ways, using credit history, capacity to pay, and sometimes secured assets. The platforms usually spread lenders’ funds across a range of borrowers, and facilitate payments and repayments.
However minimum regulatory guidelines ensuring good practice will protect the sector from “fly-by-night” entrants with lower standards. Setting those minimum standards well can only be done with comprehensive data on the alternative finance sector.
We don’t want to lose or delay the benefits of digital disruption in finance simply because not enough is known about the structures and participants.
Author: Susan Thorp, Professor of Finance, University of Sydney
The current international tax regime was developed in the last century when the internet was not yet invented. At that time, a foreign company would typically require a substantial physical presence in Australia before it could be in a position to earn significant amount of income from Australian customers. This is what’s known in the tax world as permanent establishment.
The concept of permanent establishment is embedded in most domestic tax laws as well as virtually all the 3,000 plus tax treaties in the world. It dictates that in general, business profits of a foreign company will be subject to tax in Australia only if the company has a permanent establishment in Australia. In other words, the ATO cannot tax a foreign company’s profits if it has no permanent establishment in Australia.
The recent hearings of the Senate inquiry into corporate tax avoidance made it clear the tax structures of Uber, Airbnb, like their older peers Google and Microsoft, are designed to ensure income from Australian customers is earned by a foreign company that does not have a permanent establishment here. The permanent establishment concept is not effective for today’s digital economy.
Uber’s business and tax structure
Take Uber, which though established in the US, has a wholly-owned subsidiary in the Netherlands, which in turn has a wholly-owned subsidiary in Australia.
The most important asset of Uber is its digital platform that supports the app linking individual drivers and their customers. It’s unlikely this app was developed in the Netherlands. Despite this, Uber-Netherlands has the right to book income generated from customers in Australia.
For example, if a customer pays $100 for a ride in Sydney booked through the Uber app, the money is in fact paid to Uber-Netherlands. Out of the $100, Uber pays the driver about $75. The gross profit of $25 is booked in the Netherlands. This is so even though the transaction happens largely in Australia, including the driver, the customer and the ride.
Uber-Australia receives a service fee from Uber-Netherlands for its marketing and support services performed in Australia. The fee is determined based on the operating costs of Uber-Australia, plus a mark-up of 8.5%. The mark-up is effectively the taxable profit of Uber in Australia under its tax structure.
Airbnb’s business and tax structure
Airbnb, another young business founded in the US, has a structure very similar to that of Uber. Airbnb’s parent company in the US has a wholly-owned subsidiary in Ireland, which in turn has a wholly owned subsidiary in Australia.
Airbnb charges fees to both hosts and guests for accommodation booking through its digital platform. Instead of Airbnb-Australia, Airbnb-Ireland books the fee income generated from accommodation bookings in Australia. This is so even if the host, the guest and the accommodation are all in Australia. For example, if a Sydneysider uses the Airbnb app to book accommodation in Melbourne, the payment is in fact paid to Airbnb-Ireland. The host of the accommodation is then paid by Airbnb-Ireland which charges a fee of 3%.
Airbnb-Australia is responsible for the marketing activities in Australia. It receives a service fee from Airbnb-Ireland for those activities, and the fee is again computed based on its operating costs plus a mark-up.
Déjà vu – Google and Microsoft
Comparing the tax structures of Uber and Airbnb with that of Google and Microsoft reveals striking similarities. It suggests that the appetite for tax planning is comparable between established and relatively “young” technology companies.
The common pattern: a parent company in the US establishes wholly owned subsidiaries in market jurisdictions (such as Australia) as well as in low-tax countries.
While the commercial reality is that all companies in a group are effectively one single enterprise, the tax law in general treats each company as a separate taxpayer.
On one hand, the Australian subsidiary typically is responsible for marketing and support services that have to be physically done in Australia, and earns a service fee on a cost plus basis. The amount of profits subject to tax in Australia is usually very small compared to the income generated from Australian customers.
On the other hand, intellectual properties – which are often the most important and valuable assets of technology companies – are located in low-tax jurisdictions such as Ireland, the Netherlands and Singapore. This structure allows those low-tax subsidiaries to book the income generated from customers in Australia, and effectively shields the income from the Australian tax net.
Policy responses
Action item 1 of the OECD’s base erosion and profit shifting (“BEPS”) project is “tax challenges of digital economy”.
The original intention of the OECD was to explore how the 20th century international tax regime should be reformed in response to the digital economy in the 21st century. It quickly realised it was extremely difficult, if not impossible, to achieve international consensus on the intended reform. The often conflicting and vested interests among countries present a formidable obstacle to international consensus on meaningful reform of the international tax regime.
Instead of relying on the BEPS project to resolve the issue, Australia has followed the lead of the UK and is in the process of introducing the Multinational Anti-Avoidance Law – commonly known as the Google tax – to address the issue. As the new law incorporates concepts that are new and untested, it is not clear whether it will be effective.
In any case, it’s important to remember that multinational corporations are very agile. They may replace their “avoided permanent establishment” structures to circumvent any Google tax or to incorporate new tax avoidance tools.
Author: Antony Ting, Associate Professor, University of Sydney
Since his swearing in as Prime Minister in September, Malcolm Turnbull has often referred to himself as a “reformer”. In particular, Turnbull has made clear that the time for a change has come.
The Abbott-Hockey plan to “end the age of entitlement” is over, and growth will be placed at the centre of Turnbull’s economic agenda. An expansionary fiscal policy, based on borrowings to fund public infrastructure such as roads, urban public transport, ports and water infrastructure is something the prime minister is seriously considering.
While public spending may intuitively be seen as one of the drivers of economic growth, the academic evidence in favour of it is mixed. True, there’s some evidence in favour of large output returns from fiscal spending. But this evidence typically arises when spending is implemented in particularly severe economic recessions, and not necessarily in mild economic downturns. Moreover, a well-designed fiscal plan should explain not only the spending side, but also the revenue one. How is the government planning to cover public spending?
Of course, if public spending is presented hand-in-hand with expectations of prosperous future growth, public sustainability falls out of the discussion. After all, why shouldn’t we spend now if resources to cover this spending will emerge in the future? However, expectations of prosperous growth must be formulated with care.
As we now know, and as predicted, the Abbott-Hockey plan to return the budget to surplus was conditional on overly-optimistic assumptions regarding future growth – a 3% rate of growth for potential output was envisioned.
In his address to the Australian Business Economists Conference delivered two days ago in Sydney, Treasury deputy secretary Nigel Ray talked about a slowing down of future working-age population growth to 1.5%, lower than the 1,75% growth assumed by the budget last May. The result? Fewer people engaged in working activities, all else being equal, implies a more moderate future growth of Australia’s potential output, which is now expected to be 2.75%, below the 3% assumed by the budget.
And a lower amount of resources in the future, combined with an ageing population, implies more public spending for health care and less revenues from taxation, which means a bigger deficit. Consequently, adjustments must be made to keep the level of public debt under control.
To be clear, financial markets still point to the Australian economy being a solid one, and the debt service promised by the Australian government in order to issue its public debt is still among the lowest among industrialised countries.
To support the perceptions held by financial market operators, Turnbull should clearly communicate his fiscal plan, and how it differs from that of Abbott-Hockey, conditional on the latest revisions on Australia’s future growth. This communication should be constructed on two pillars. Firstly, on credible assumptions on the fiscal multipliers the government expects public spending to generate, and secondly, on cautious predictions on economic growth. Figures on future growth coming from independent sources external to the government should be employed to construct future scenarios which account for the inescapable uncertainty surrounding economic predictions.
It’s not surprising this year’s Mid-year Economic and Fiscal Outlook, due mid-December, is being eagerly awaited by so many Australians.
Author: Efrem Castelnuovo, Principal Research Fellow, Melbourne Institute of Applied Economic and Social Research – Associate Professor, Faculty of Economics and Business, University of Melbourne
It’s no secret that our superannuation system is unfair. Over half the value of the tax breaks goes to the top 20% of income earners, people who already have enough resources to fund their own retirement.
As shown in our new report for Grattan Institute, Super tax targeting, the system provides overly generous opportunities to contribute to super. These opportunities are usually defended on the grounds that people with broken work histories, especially women returning to work, can “catch up” before retirement. Super lobby groups make a lot of noise about middle-income people scrambling to build a decent nest egg for retirement, and our super system bends over backwards to help them.
But it’s hard to find many middle-income earners in real life who make large voluntary contributions to super. Instead the system mainly creates large tax-planning opportunities for many more people who already have enough resources to fund their own retirement. The plight of catch-up contributors is the tail that wags the super dog.
Author provided
Superannuation tax breaks allow people to pay less tax on their super savings than is paid on other forms of income. Annual caps on super contributions act as a brake on the system’s generosity, and its cost. If set at the right levels, these caps prevent high-income earners from abusing generous super tax breaks to lower their tax bills.
Yet Australia permits larger voluntary contributions to superannuation than many other countries. The flat 15% tax rate is applied to contributions made from pre-tax income – delivering enormous tax breaks to high-income earners on high marginal rates of income tax. Even where superannuation contributions are made from post-tax income, savers then benefit from generous tax breaks on super fund earnings, only taxed at 15%, or zero in retirement.
Catch-up contributors are a myth
All the evidence shows that very few middle-income earners, and even fewer women, make large catch-up contributions to their super funds. Only 12% of taxpayers, or about 1.6 million people, make large pre-tax contributions of more than $10,000 a year, and that includes compulsory super paid by their employer. Just 164,000 women earning less than $77,000 make such large pre-tax contributions. However 935,000 men earning more than $77,000 do so. These high-income savers get a tax break on the way in, and then pay little or no tax on their super earnings.
Author provided
Why do so few middle-income earners make large catch-up contributions? Put simply, they can’t afford to. In 2012-13, the median taxable income in Australia was $41,561. Gross incomes (before any deductions) are not much higher. More saving boosts incomes in retirement, but it reduces living standards today. This fundamental trade-off is rarely discussed in the superannuation debate.
Benefits flow to high-income earners
Not surprisingly it is mainly high-income earners who have the disposable income to put more than $10,000 a year into their super. They get large tax breaks, even though they are likely to retire with enough assets to be ineligible for an Age Pension.
The cap on post-tax contributions is even more generous. It allows people to contribute up to $180,000 per year. People under age 65 can also bring forward an extra two years’ contributions, so they can put in up to $540,000 during a single year, and that’s on top of up to $35,000 in contributions from pre-tax income.
These post-tax contributions total $33 billion a year – about three times the size of voluntary pre-tax contributions. Many post-tax super contributions appear to represent tax-planning rather than any genuine increase in retirement savings. Of all post-tax contributions, around half are made by just 200,000 people who already have at least $500,000 in their superannuation. Only 1.2% of taxpayers have total super account balances of more than $1 million, yet this tiny cohort accounts for 26% of all post-tax contributions. By contrast, the 70% of taxpayers with super balances of less than $100,000 make just 9 per cent of total post-tax contributions.
Author provided
Lifetime caps would likely make things worse, unless set at very low levels. To maximise their superannuation tax breaks, taxpayers who have not used up their lifetime pre-tax cap could sacrifice the entirety of their earnings into super. Such tax planning is likely given how super tax breaks are used already.
Counting the cost
Whatever the benefits of superannuation tax breaks, they must be balanced against the costs. Superannuation tax breaks cost a lot – over $25 billion in foregone revenue, or well over 10% of income tax collections – and the cost is growing fast. Lower-income earners and younger people have to pay more in other taxes – both now and in the future – to pay for the tax-free status of so many retirees.
The way forward
Caps on super contributions need to strike a better balance between allowing those with broken work histories to contribute towards a reasonable superannuation balance, and restricting the opportunities for tax minimisation by those unlikely to qualify for an Age Pension. That means being realistic about the level of catch-up contributions that are likely from those who are genuinely making up for broken work histories.
Grattan Institute’s new report, Super tax targeting, recommends three reforms to better align tax breaks with the goals of superannuation.
One, annual contributions from pre-tax income should be limited to $11,000 a year. This change would improve budget balances by $3.9 billion a year. There would be little increase in future Age Pension payments since the reductions in tax breaks would mainly affect those unlikely to receive an Age Pension anyway.
Two, lifetime contributions from post-tax income should be limited to $250,000. It won’t save the budget much in the short term, but in the longer term it will plug a large hole in the income tax system.
Three, earnings in retirement – currently untaxed – should be taxed at 15%, the same as superannuation earnings before retirement. A 15% tax on all super earnings would improve budget balances by $2.7 billion a year today, and much more in future.
Previous repeated changes to superannuation have been too timid. Decisive reforms must target super tax breaks at those who need them most, and limit the benefits for those who don’t need them. Until then the system will keep chasing its own tail.
Authors: John Daley, Chief Executive Officer , Grattan Institute; Brendan Coate, Senior Associate, Grattan Institute.
Australia’s quest to develop a stronger innovation ecosystem has seen a growing focus on the income tax system, and whether it should be used as a lever to help achieve this goal.
Some have argued the government should not use tax incentives to spur the shifts needed to make Australia an innovation hub. This view is based on the argument that tax incentives have never been central to the success of Silicon Valley or Israel’s innovation ecosystems. However, there has been little analysis of why this is so and no-one has stopped to ask whether this analogy is apt for Australia.
Australia is in a very different position now to where the US was from the 1970s through to 2000 when Silicon Valley went through the biggest phase in its development. One part of this difference is the level of military expenditure available for investment in technology.
In the US, between 1970 and 1992, the lowest level of military expenditure as a percentage of GDP was 4.6%. At the start of the 1970s, the level was much higher (7.8%), and that was a decrease from the level in the 1960s (in 1962 and 1968, the level was 9.0% and 9.1% respectively). Between 1992 and 2001 in the US, the level steadily fell from 4.3% down to 2.9%.
There are various reasons for the fluctuations across time, including engagement in war (the Cold War and the Vietnam War) and changes between Democratic and Republican administrations. But the broader point is that the baseline of military spending in the US at the crucial stage in the development of Silicon Valley was very high. The same is true of military spending in Israel – in 2014, military expenditure accounted for 5.2% of GDP. That is the lowest level of military expenditure there for at least 15 years.
By comparison, the level in Australia in 2014 was much lower, at 1.8% of GDP. This is nothing near the historic levels in the US or the relatively recent levels in Israel. While only a small proportion of military expenditure will be invested in new technology in any country, countries that have had high levels of military expenditure have had higher levels of investment in new technology.
Submarines alone won’t do it
Some have pointed out that, given the importance of military investment to the ecosystems in Silicon Valley and Israel, Australia’s next submarine contract is vital. However, one contract is unlikely to be enough to single handedly develop technology that can dramatically transform the existing landscape and provide a backbone for the future of innovation in Australia. (No pressure, right?) This also raises a broader question about whether it’s possible for Australia to increase its current level of military expenditure and whether that is what we want.
In addition to the disparity between military expenditure in Australia and the US, there is a huge difference in scale of GDP. In 2014, Australian GDP was approximately US$1.454 trillion and US GDP was US$17.419 trillion. The sheer scale of US GDP is significant due to the failure rate of startups. Anecdotally the failure rate for tech startups in the US is around 90%. A lot of capital is lost in the quest to find the next Facebook or Snapchat. Scale helps innovation.
Further, an important part of the success of US startups has been the scale of their domestic market. Exporting to international markets has tended to come much later (although this temporal lag was more pronounced in the 1980s than it is now).
In Australia, the relatively small size of the domestic market means Australian startups will need to export much earlier in their lifecycle. Ian Maxwell has previously suggested that a startup tech sector in Australia could be successful if startups were acquired by the corporate sector, and established corporations then went through the process of commercialising and exporting the process or technology globally. This point is worth exploring further. His broader point – that Australia is going to need to come at the problem differently to the US – is compelling given we are building from a different baseline, in different conditions and with very different parameters. We need to work with our strengths.
Given the figures above, it’s highly unlikely investment from military spending alone will be able to sustain an innovation ecosystem in Australia. Given the capital required to commercialise research and innovation and the size of our economy, we will need to be clever about how to drive capital towards such an ecosystem.
Tax concessions may not be the silver bullet. Based on past experience, e.g. with concessions for film, R&D and infrastructure bonds, any concessions would need to be tightly controlled to prevent manipulation and avoidance. However, it seems unwise to completely dismiss the tax system as playing a role in achieving the economic shift we are seeking.
One idea worth exploring further is whether it is valuable to undertake some rebalancing between the level of concessions and subsidies that are currently directed towards individuals and those directed towards business vehicles, even if this is only temporary. The rationale is that a flourishing and productive private sector may remove the need, or assume responsibility, for providing some of the benefits to individuals. The UK seems to have had some success with that strategy.
In this vein, some have recently argued that the revenue lost to negative gearing and the investment in real property that it has encouraged would be better redirected towards the startup sector.
In 2015, NATSEM estimated that Australia currently foregoes A$3.7 billion in revenue each year to negative gearing of residential property (A$7.7 bn when combined with the CGT discount) and there’s also evidence negative gearing mostly benefits higher income taxpayers.
Abolishing the Australian tax sacred cow of negative gearing would be unpopular. But it is the type of change we should be considering if we really want to direct investment towards innnovation.
Author: Alex Evans, Lecturer in Tax Law, Australian School of Business, UNSW Australia
Average income earners largely are the people who do get to take advantage of negative gearing – nurses, policemen and women on an average wage, investing, for instance, in a property. Most of them hold only one property, which adds to the housing stock that’s available for people as well. – Assistant Treasurer and Small Business Minister Kelly O’Dwyer, speaking on ABC TV’s Insiders, October 25, 2015
Negative gearing is a tax break available for people who own at least one other property in addition to their primary place of residence. This tax break applies only if the costs associated with the investment, including interest payments and other expenses, are greater than the rental income. Any loss made on the property can be offset against other income, thus reducing personal tax.
It’s true many nurses and police officers and other middle-income (and even much lower) people have negatively geared properties. But are these occupations and incomes the typical beneficiaries of negative gearing?
Checking the data
When asked for a source to support her statement, a spokesperson for O’Dwyer sent the following statistics.
• Taxation statistics show 66.5% of taxfilers who declare a net rental loss have a taxable income of A$80,000 or less.
• Those who use negative gearing include 22.6% of police officers, 19.2% of ambulance officers and paramedics, and 18.9% of train and tram drivers.
• Of the Australians who use negative gearing, the majority only hold one additional property.
• 73% of people with a rental property interest have only one property and 18% own two.
A$80,000 per year is not a typical taxable income. Around 84% of non-investors have a taxable income below $80,000. This compares with the 66.5% of people with negative geared property.
It is true that a relatively high proportion of the listed occupations have negatively geared properties. While it may be the popular belief that these are low or middle income occupations, these are actually reasonably highly paid occupations. For example, 73% of train and tram operators earn more than A$80,000 per year.
In our analysis, we looked at the income distribution of people who negatively gear compared to that of people who do not invest in rental properties.
The data set we used is called the 2012–13 individuals sample file. To collect this data, the Australian Taxation Office (ATO) sampled 2% of all individual tax returns filed in 2012-13.
According to this ATO data set, there are 1.26 million (10%) taxpayers who negatively gear. Their average loss was A$8,930 per year. A further 700,000 with a rental investment are positively geared (meaning their rental income was greater than their costs). About 85% of taxpayers don’t have a rental investment.
The chart shows what statisticians call the “smoothed” probability distribution (which is a smoothed histogram of the income distribution) of taxable income for people with negatively geared properties and people without rental investment properties. Marked also on the chart are the median and top 10% (P90) income points for both people with negatively geared properties and those without property investments.
The median income for negatively geared investors is A$60,000 per year, compared with $40,000 for non-investors.
A similar gap (50%) exists at the top end of the income spectrum. The taxable incomes of the top 10% of earners with negatively geared investments is around $150,000 compared to $98,000 for non-investors.
The chart shows clearly that, typically, people with negatively geared properties have significantly higher incomes than people without property investments.
In an April 2015 analysis commissioned by GetUp! for the Australia Institute, NATSEM found that 34% of the tax benefits of negative gearing accrues to the richest top 10% of families, as this chart from the report shows.
Only around 20% of the tax benefits go to the bottom half of the income distribution.
High-income families invest more money than low-income families. The tax system benefits high-income earners more than low-income earners due to higher marginal tax rates amplifying the effectiveness of deductions.
The role of capital gains
Negatively gearing property implies that the investor is making a loss on their investment. As the chart below shows, the tax savings are greatest among those in the higher tax brackets. However, it remains the case that these investors continue to make an overall loss on their investment, even after accounting for tax deductions.
The success of negative gearing as an investment strategy is reliant upon capital gains. In a property upswing, this strategy can be highly successful with lucrative gains on often minimal equity investment. During a property downswing or period of limited price growth, these strategies are very poor investments.
A recent analysis by the Grattan Institute shows that while police and nurses do invest in property, it is the higher-income occupations, such as doctors and mining engineers, who are much more likely to invest.
Adding to the housing stock?
Property investment only improves housing affordability when the purchase adds to the stock of newly constructed dwellings in affordable housing.
According to CoreLogic RP Data, in 2014 there were just under 500,000 property transactions and ABS building completions data suggest only around a third of those were newly built dwellings. It therefore stands to reason that most property transactions each year are probably existing stock.
Verdict
O’Dwyer’s assertion is not supported by the data. ATO data shows that, typically, negatively geared investors have higher incomes than people without rental investments.
The same data shows that negatively geared investors have typical incomes around 50% higher than non-investors – even after deducting their losses from negative gearing.
The top 10% of the income distribution for negatively geared investors earn around 50% more than non-investors. Incomes for this top 10% are around $150,000 per year, compared with $98,000 for non-investors, according to the ATO. – Ben Phillips and Cukkoo Joseph
Review
While I agree with everything in the above FactCheck, I would go further in criticising Kelly O’Dwyer’s statement, particularly the reference to investors adding to the housing stock.
The figure cited above for the ratio of housing purchases for new housing stock includes owner occupiers.
The impact on housing stock is tiny, but the effect on housing affordability of all those investors bidding up the prices of existing housing is likely to be substantial. – Warwick Smith
Authors: Ben Phillip, Principal Research Fellow, National Centre for Social and Economic Modelling (NATSEM), University of Canberra; Cukkoo Josep, Research Assistant, University of Canberra.
Reviewer, Warwick Smith,Research economist, University of Melbourne
John*, a widower, is a retired engineer aged in his 90s. He lives alone in the family home and has struggled with loneliness and depression since his wife passed away. He feels frustrated that as he gets older he can no longer do many of the things he used to enjoy, which exacerbates his sense of feeling alone in the world.
Social isolation in old age
In Australia, one-quarter of people aged 65 and above live alone. Some older people, like John, will be vulnerable to social isolation, which occurs when people have limited opportunities for human contact and become disconnected from society.
Not all older people who live alone are socially isolated. And social isolation is certainly not limited to old age. But social isolation in old age is a significant concern. It is linked to a range of health problems and, in extreme cases, can lead to people growing old and dying alone.
There have been public calls to address social isolation. Earlier this year, UK Health Secretary Jeremy Hunt controversially urged people to invite lonely elderly strangers into their homes in an effort to avoid “lonely deaths”. In Australia, many aged care organisations and local councils offer social programs designed to help older people stay connected to others.
But for older people with limited mobility it can be difficult to take part in organised social activities. And not everyone wants to invite strangers into their homes. For these people, social technologies could provide valuable opportunities to stay connected to the world.
Older people and social technologies
Older people are going online at growing rates and social networking is no longer considered the domain of the young. Pew Research Centre found that that more than half of American internet users aged over 65 now use Facebook.
But not all older people feel comfortable using social networking sites. Existing sites, such as Facebook, can be confusing, with too many functions, distractions and extraneous information. Some older people, meanwhile, fear a loss of privacy and malicious intent when communicating online.
Researchers at the University of Melbourne developed a prototype iPad application, Enmesh, to explore how social technologies can be used to help alleviate older people’s experience of social isolation. The app was a simple social networking tool designed to be easy, fun and safe to use. Its simplicity meant it avoided many of the problems that make existing social networking tools difficult or unattractive for older adults.
Enmesh was used to share captioned photographs and messages within a closed group. The photographs then appeared on an interactive display on each person’s iPad screen. This provided a safe and fun space for people to learn how to use the iPad’s touchscreen and camera while also developing new friendships.
John was one of several older adults, mostly aged in their 80s and 90s, who took part in a series of studies to trial Enmesh. During the study, John shared over 100 photographs and messages with other older adults, all strangers to him at the start of the project.
Sharing photographs might seem like a simple and familiar form of communication to those of us who use social media every day. But for John, and others like him, it was a revelation.
Many of John’s captioned photographs provided personal, poignant – and sometimes humorous – descriptions that illustrated how he felt about ageing. Others could relate to his experiences and felt they got to know John through his photographs.
One of the older adults John connected with was Sarah*. She said the project gave her a sense of belonging to a group. She enjoyed sharing and seeing other people’s photographs. They provided “little snippets” that gave her insight into people’s lives. Sarah said:
It’s lovely to have conversations and I don’t have nearly enough, as I rarely go out or have visitors. I love it when one of those things is possible, but in the meantime this is a wonderful way of keeping in touch with folk.
Older adults who are socially isolated may have few opportunities to share information about their day-to-day lives. Photo-sharing with peers provides an important outlet for this communication.
Empowering older people
Technological innovations for older people – such as emergency alarms and devices that monitor activity – are typically designed to compensate for frailty and provide peace of mind for family members.
While these innovations are important, the Enmesh study has shown that technologies can offer powerful social opportunities for older people too.
As consumer technologies continue to advance, there will be more opportunities to enhance older people’s social worlds through technology. Alongside growing innovation, we need to build capacity in the aged care workforce to ensure the aged care industry is mobilised to take advantage of new technologies.
*Names have been changed.
Author: Jenny Waycott, Lecturer in the Department of Computing and Information Systems, University of Melbourne
The taxation of superannuation has been the cause of much consternation. Much of the difficulty is the result of the slow drift of superannuation from the moorings of its original purpose.
In introducing the superannuation guarantee in 1992, the Keating government was pursuing an ideal firmly centred on the ordinary person of ordinary means. The hope was to extend superannuation to the entire workforce as a means of ensuring working people were not wholly dependent on the state in funding their retirement.
Over time though, this vision has been lost. A succession of reforms have seen superannuation gradually assume the function of a tax shelter for the wealthy. The concessions available under the present framework are overwhelmingly skewed towards those who are perfectly capable of funding their retirements without government assistance of any kind.
These three reforms would promote fairness and equity in the taxation of superannuation.
Fund earnings are, in general, taxed at a rate of 15% while the fund is accumulating, and are tax-free once the fund is being used to provide a pension. The benefit of this is relatively modest for those to whom a low marginal income tax rate applies.
But for those who have large funds and to whom the top income tax rate applies, the value of this concession is extraordinary. By concentrating assets within super, wealthy individuals are able to avoid the high tax rates which would apply to those assets’ earnings if they were held in the individuals’ own names.
The burgeoning self-managed-super-fund advisory industry is testament to the zeal with which high-net-worth individuals are pursuing the tax advantages which the present system affords.
Superannuation was never intended to operate as a tax shelter for the earnings of multi-million-dollar equity portfolios. There is a strong case for introducing progressive taxation of fund earnings to prevent this misuse of super.
Lower the cap on concessional contributions
The general concessional contributions cap presently sits at $30,000. This means that individuals can contribute up to $30,000 to their super from their pre-tax income in a financial year (including any employer compulsory contributions) and pay a concessional tax rate (usually 15%).
There is a very strong case – put by the Grattan Institute’s John Daley in April – that this general concessional cap is far too high. The present figure represents a huge proportion of the annual income of the average Australian. Most workers are simply unable to take advantage of the full extent of the tax concessions available.
The lion’s share of the benefits are therefore captured by those with large incomes who can afford to make voluntary super contributions by way of salary sacrifice. While it is sensible to encourage workers to make voluntary contributions to super, it must be recognised that the average Australian is simply unable to spare tens of thousands of dollars a year for this purpose.
Retain the low income super contribution
One of the peculiarities of the current system is that some low-income workers are actually made worse-off by the ‘concessional’ contribution tax rate.
Take, for example, a part-time cleaner who earns $15,000 per annum. This income falls below the tax-free threshold, and therefore attracts no income tax. But the compulsory employer contributions made on this worker’s behalf are still taxed at the standard concessional rate of 15%. The profoundly unfair result is that this worker’s super contributions are subject to a “concessional” rate which is actually higher than the tax rate applied to his or her ordinary earnings.
This is currently remedied by the existence of the Low Income Superannuation Contribution, which operates to reverse this unfair result for those who earn under $37,000 per annum. The motivations which underlie this policy are admirable. But the LISC is due to cease on 30 June 2017, and the government has not yet indicated an intention to extend its life or make it permanent. If the LISC is permitted to cease, the result will be a system which actively disadvantages the least well-off while directing substantial largesse to the wealthy. This would be an extraordinary outcome.
If the government is serious about superannuation reform, it should be looking closely at some of these. The opportunity of raising revenue while taking super back to its original purpose is too good to pass up.
Author: John Eldridge, PhD Candidate, Adelaide Law School, University of Adelaide
