Tag: The Treasury

The Economic Foundations of Tax Reform

Roger Brake, Division Head, Tax Framework Division at The Treasury gave an interesting speech today “Tax Reform and Policy for an Economy in Transition”. Essentially, we face a number of headwinds, including falling productivity, shifting demographics, slower growth, more adverse terms of trade and rising personal income tax. I have selected some of the more striking charts, but the entire speech is worth reading.

Treasury is establishing a new, ongoing Tax Framework Division to sit alongside our two existing policy divisions, our Law Design Practice and our quantitatively-focussed Tax Analysis Division.

This Division will be responsible for thinking about cross-tax system issues, including how economic developments are affecting the tax system. It will also monitor international developments in tax at a high level, both in terms of the structure of other countries tax systems and advances in thinking on key tax issues. It will also engage on state tax issues. The Division is also expected to play a role progressing the tax simplification agenda.

The Division will engage closely with other Treasury divisions, academia, the private sector and our State and Territory counterparts.

The Australian economy is recording good growth relative to other advanced economies and is transitioning away from the boom in mining investment towards broader growth. However, growth in living standards is not projected to return to mining boom levels. This has implications for the revenue our tax system will generate. It means that, for a given share of tax to the overall economy, the annual growth in revenue is not expected to be as strong as in the past.

Changes in the composition of the economy, and technological developments, will continue to affect the composition of tax revenues. Predicting the magnitude and speed, and in some cases even the direction, of these developments is very difficult. Nevertheless, it is important that these developments continue to be watched very carefully for their revenue implications over time.

The Government has a large and important tax agenda. The reforms will boost our international competitiveness, while improving the integrity and sustainability of the tax system. Treasury is working on the policy and legislative products needed to implement those policies.Treasury is also focussing on simplification proposals, working particularly with the Board of Taxation.

To ensure that a whole-of-tax approach is brought to bear on key issues, Treasury is establishing a new Tax Framework Division. We are also continuing to build our internal capacity and our engagement with stakeholders.

Productivity

In terms of productivity, advanced economies have experienced a long-run trend decline in productivity growth (Chart 3). Australia and the US had a brief period of strong productivity growth in the late 1990s and early 2000s (due to a combination of microeconomic reform and gains from information and communications technology but growth has since slowed).

Chart 3: Productivity growth rates – Australia, USA and advanced economies

Source: Treasury

Note: Productivity growth rates are presented as a rolling five-year average to minimise annual volatility and highlight more persistent trends.

As you can see from this chart, we are not alone. Indeed the OECD estimates that almost all of its member countries have experienced a slowing of productivity growth since 2000, coupled with an increased divergence between the productivity growth rates of leading businesses and other businesses.

What explains this poor productivity performance among advanced economies? How do we reconcile it with dramatic changes in technology, including the sweeping changes we all experience from the digital economy? This is one of the big issues facing economists and so far there is no consensus on why it has happened. This matters a lot to Australia – in the long run, our potential productivity growth is constrained by the global ‘productivity frontier’.

Demographics

Demographic pressures, including slower population growth and ageing populations are already having a profound effect on the global economy and this will continue.

Ageing populations in many advanced economies are likely to lead to a decrease in participation rates in coming decades and as a result, there will be a smaller share of the population active in the workforce. This trend is already evident in the two largest advanced economies of the world – the US and Japan. The traditional working age populations (people aged 15 to 64) of our top two export destinations, China and Japan, are shrinking (Chart 4).

A key question is: to what extent the effects of an ageing population are offset by higher participation rates. In Japan, for example, the labour force participation rate has fallen from 64 per cent in 1992, when the working age population peaked as a proportion of the total population, to 59.6 per cent in 2015. This is despite an increase in the participation rate of the working age population, primarily driven by an increase in female labour force participation in this age group from 58.3 per cent to 66.7 over the same period.

Chart 4: Growth in working age populations

Source: 2015 UN Population Prospects, ABS, Treasury

Australia’s economic transition

Against this backdrop, the Australian economy is in the midst of a transition from mining investment to broader based drivers of growth.

In 2011-12 mining investment contributed 2.8 percentage points to GDP growth. At Budget, mining investment was expected to detract around 1½ percentage points from growth in 2015-16. Rather, household consumption, dwelling investment and exports have been supporting activity and this is expected to continue in the near term. The Budget forecast real GDP to grow 2 ½ per cent in both 2015-16 and 2016-17 before strengthening to 3 per cent in 2017-18. This is a little lower than the 20 year average of 3.2 per cent (Chart 8).

Chart 8: Real GDP growth

Real GDP measures the volume of goods and services we produce. However, our national income depends not only on the volume of what we produce, but also our terms of trade. During the 2000s, commodity export prices rose much faster than import prices, leading to an unprecedented surge in the terms of trade, and strong growth in incomes (Chart 9). After the financial crisis, strong Chinese demand for our mining exports pushed up commodity prices and helped insulate Australia from the weak growth experienced in many parts of the world. Following a peak in the terms of trade in September 2011, steep falls in commodity prices have weighed on national income since that time.

Chart 9: Terms of trade

Source: ABS Cat. No. 5206.0

Over recent years, large increases in supply, including from Australia, combined with moderating global demand, primarily from China, has seen commodity prices fall significantly from their peaks. This has caused the terms of trade to decline and the Australian dollar to depreciate.

The lower nominal exchange rate has facilitated the transitions taking place by providing significant support for firms producing tradeable goods and services. Indeed services exports have expanded noticeably over the past few years, especially in tourism, education and business services.

This is combining with low wage growth to put downward pressure on the real exchange rate and help improve Australia’s competitiveness internationally. These forces should continue to assist the adjustments taking place in the economy and encourage firms to employ more workers. This has been aided by strong growth in the economy’s labour-intensive services industries, as well as workforce flexibility – which has allowed firms to adjust labour input through changes in hours rather than employment levels.

As with any adjustment, the economic transition may not be smooth and is subject to uncertainty. Non-mining business investment is taking longer than anticipated to pick up, despite accommodative conditions being in place.

The most recent measure of business’ expected capital expenditure shows that non-mining businesses have not yet committed to significant new investment plans in 2016-17.

The pipeline of dwelling investment means it should continue to grow strongly over the next year but beyond that time it is not expected to contribute significantly to growth.

The expected continued growth in consumption spending is also dependent upon the savings rate continuing to fall. While the savings rate has been trending down since its peak in 2011-12, it is unclear where it will settle.

Demographics

In the medium term, Australia’s economic growth will be determined by the size of the labour force – both population growth and rates of labour force participation – and labour productivity.

In terms of Australia’s demographics, our story is similar to that in many parts of the world. Our population is ageing, reflecting continued gains in life expectancy and declines in fertility rates. This means that in the future, there will be a significantly smaller share of people of traditional working age, that is, between 15 and 64 years of age (Chart 10)ii. The Intergenerational Report (IGR) released in March 2015 noted that in 1974-75 there were 7.3 people in this age group for every person aged 65 and over. This decreased to 4.5 people by 2014-15 and is projected to decrease even further to 2.7 people by 2054-55.

Chart 10: Number of people aged from 15 to 64 relative to the number of people aged 65 and over

Source: 2015 Intergenerational Report.

This will place downward pressure on workforce participation which will detract from economic growth and growth in living standards.

By 2054-55, the participation rate for Australians aged 15 years and over is projected to fall to 62.4 per cent in 2054-55, compared with 64.6 per cent in 2014-15.

Despite this broad trend, there have been some positive trends in participation amongst older Australians and women.

Between 1978-79 and 2013-14 the participation rate of people aged 55 to 64 increased from 45.6 per cent to 63.8 per cent. Older people have been able to extend their labour force participation as a result of the improvements that have led to longer life expectancy, the rise of less physically demanding work and new technologies.

In addition, there has been strong growth in female participation over the past 40 years. In 1975, only 46 per cent of women aged 15 to 64 had a job. Today around 66 per cent of women aged 15 to 64 are employed. By 2054-55, female employment is projected to increase to around 70 per cent. The increase in female participation rates has been the result of increased levels of education, changing social attitudes towards gender roles, declining fertility rates, better access to childcare services and more flexible working arrangements.

While this is positive, at 70 per cent there are quite clearly further gains that can be made on this front.

For this reason, there has been, and will likely continue to be, a focus on the drivers of participation among groups with lower participation rates, including women and older Australians, and the role for policy.

Productivity

While lifting participation will deliver a growth dividend, it is widely acknowledged that improvements in productivity will be the key driver of Australia’s medium term growth prospects and indeed living standards.

Chart 11 shows the sources of our national income growth over the past five decades. Productivity growth has played the leading role in increasing our prosperity. However, as the chart makes clear, challenges are ahead.

Chart 11: Contribution to per capita income growth

Source: Treasury

In a period of falling terms of trade and labour force participation, future growth in living standards will again rely more heavily on labour productivity growth.

Economic developments and the tax system

Let me turn now to what these economic developments mean for the tax system.

Understanding these developments is a very important task for Treasury. Clearly, it is critical for the Government and the community that we have a tax system that raises revenue in a robust way to enable effective government budgeting. So we collectively have a keen interest in how changes in the economy and the way business operate will affect our revenue base over time.

While this is very important, it is also very challenging. The economy is always evolving in ways that are hard to predict. Even looking at past data, it can be hard to divine what will be a long term trend and what may be a cyclical phenomenon that will have only a transitory effect. Even where there are some relatively easy-to-predict structural changes, accurately quantifying the magnitude of the effect and the time horizon over which it will occur can be fraught.

So, with those caveats in mind, let’s look at what has happened to tax trends and what may happen going forward.

Let’s first look at the aggregate story for Commonwealth revenue – the tax:GDP ratio.

Chart 12 shows the evolution of the Commonwealth’s tax:GDP ratio since 2001-02 (excluding the GST). Following a sustained period where the ratio was around 20 per cent, it fell to below 17 per cent. This fall was more severe than at any time since the 1950s. The ratio has slowly increased to be almost 19 per cent, and is projected to reach around 20 per cent by 2019-20.

Chart 12: Total Taxation Receipts as a proportion of GDP (excluding GST)

Source: Treasury

It is important to note that the tax:GDP ratio is not only a function of tax policy but also changes in the structure of the economy, changes in asset prices, changes in consumption patterns and so on.

In terms of cyclical influences on the Commonwealth’s tax receipts, high equity and commodity prices during the mid-2000s saw the tax-to-GDP ratio rise to a record high of 24.3 per cent (or 20.5 per cent excluding GST as shown in Chart 10), before falling during the global financial crisis as corporate profitability fell and asset prices fell dramatically. The economic recovery has helped lift the tax:GDP ratio subsequently.

Changes in the pattern of consumption and activity have also contributed to the underlying trend decline in the tax:GDP ratio. The relative declines in consumption of tobacco and beer, and the trend towards more fuel efficient vehicles have all had an effect.

Structural changes to the tax base as a result of Government policy also contributed to changes in the tax-to-GDP ratio. This includes personal income tax cuts and bracket creep, the non-indexation (and now re-indexation) of fuel excise, tariff reductions and a host of specific incentives and base broadening measures.

By definition, the rise in the tax:GDP ratio in recent years means that tax receipts have grown faster than nominal GDP. However the growth in tax receipts has nonetheless been lower than during the mining boom when tax receipts were not growing faster than GDP. From 2000-01 to 2007-08, tax receipts recorded annual average growth of 7.3 per cent. From 2009-10 to 2014-15, growth averaged only 6.2 per cent.

Put another way, because GDP growth is lower, for a given tax:GDP ratio, annual revenue growth is lower. In fact, the only way to maintain revenue growth of the level experienced with the mining boom would be to have tax receipts continue to outstrip nominal GDP indefinitely.

Looking at the aggregate picture is important, but our tax system depends on the effectiveness of each of the specific revenue heads. I don’t have time to talk about all of them today, but I wanted to focus on company tax, CGT, indirect taxes and individuals income tax. While our tax:GDP ratio is projected at the end of this decade to be roughly the same as it was during the pre-GFC 2000s period, the composition will be different. Corporate tax and indirect tax will be lower, while individuals income tax is expected to be a little higher. You can see these trends in Chart 13.

Chart 13: Australia’s evolving tax mix

Source: Treasury

Note: Corporate taxes includes company tax, superannuation fund taxes, Minerals Resource Rent Tax and Petroleum Resource Rent Tax.

While cyclical and structural factors have impacted on all heads of revenue, the impact of Australia’s transitioning economy on the company tax base is perhaps most stark.

Individuals income tax

As a share of GDP, between 2004-05 and 2010-11 individuals income tax (including FBT) fell significantly (see Chart 17).

Chart 17: Individuals and other withholding taxes + fringe benefits tax as a percentage of GDP

Source: Treasury

This was largely structural, driven by a succession of individuals income tax rate reductions. Taxes on wages fell from 11.9 per cent of GDP in 2004-05 to 9.6 per cent of GDP in 2010-11, a decrease to the tax-to-GDP ratio of around 2.3 percentage points (19 per cent).

Following the crisis, the individuals income tax-to-GDP ratio has recovered and is forecast to grow as a share of GDP over the period ahead. Recognising the impact that individuals income tax can have on participation, investment in human and physical capital and entrepreneurship, the Government announced that it will increase the 32.5 per cent threshold from $80000 to $87000. It further indicated that it would consider options to reduce the burden of tax on individuals over time as fiscal settings allow.

Economic Outlook Better, Later

The Pre-election Economic and Fiscal Outlook 2016 is out.  The modelling is close to the budget numbers – though the deficit will be bigger sooner, then begin to reduce. The underlying cash balance is estimated to be a deficit of $37.1 billion (2.2 per cent of GDP) in 2016-17, improving to a deficit of $5.9 billion (0.3 per cent of GDP) in 2019-20. The current financial year deficit estimate has been changed since the budget, increasing by $100 million to $40 billion.  As with any “hockey stick” projections, you just know the timing of improvements will be uncertain.

Outlook1The 2016 PEFO uses the same projection methodology that has been used in budgets and budget updates since the 2014-15 Budget.

Treasury’s medium-term economic projection methodology assumes that any estimated gap between forecast real GDP and potential GDP closes over the first five projection years (2018-19 to 2022-23) as spare capacity in the labour market is absorbed. Beyond that point, real GDP and other economic variables are assumed to grow in line with their estimated long-run trend rates.

The medium-term economic and fiscal projections are sensitive to the assumptions that underpin Treasury’s estimate of potential GDP — that is, assumptions about population, productivity and participation. They are also sensitive to the assumed pace of the economy’s return to potential — that is, the assumption that the adjustment period lasts five years.

Analysis reported in the 2016-17 Budget shows that a faster (two year) adjustment to potential requires comparatively faster growth in real GDP and employment as the output gap closes and spare labour is put to use. This leads to lower unemployment and faster growth in wages and domestic prices, increasing nominal GDP and improving the projected underlying cash balance over the medium term even as
Pre-election Economic and Fiscal Outlook 2016 long-run real GDP is unchanged from the Budget projections. A more gradual adjustment period (eight years) is estimated to have broadly opposite effects on the projections.

Analysis in the 2016-17 Budget also shows that lower trend productivity growth than assumed in the Budget projections would directly reduce potential growth — leading to permanently lower real GDP and wages with only a small impact on prices. In this scenario, lower nominal GDP leads to lower projected tax receipts which weakens the projected underlying cash balance over the medium term. By contrast, assuming faster trend productivity growth than assumed in the Budget projections results in higher nominal GDP and tax receipts, strengthening the underlying cash balance.

Net debt, net financial worth, net worth and net interest payments are essentially the same as published at the 2016-17 Budget. In 2016-17, net debt for the Australian Government general government sector is expected to be $326.1 billion (18.9 per cent of GDP). Net financial worth is estimated to be -$427.2 billion and net worth is estimated to be -$301.0 billion.

Net interest payments are estimated to be $12.6 billion in 2016-17 (0.7 per cent of GDP). Interest payments largely relate to the public debt interest on government securities, based on the interest rates on the existing stock of Commonwealth Government Securities (CGS) and the prevailing market interest rates across the yield curve for future issuance of CGS. This PEFO assumes a weighted average cost of borrowing of around 2.5 per cent for future issuance of Treasury Bonds in the forward estimates period, the same as the assumed market yields used in the 2016-17 Budget. Yields are volatile and could vary from those assumed in the Budget. Recent movements in interest rates, if maintained, would lower the government cost of borrowing, reducing interest payments and expenses over the forward estimates. It would also reduce interest receipts earned on assets.

Economic Risks

The Secretary to the Treasury, John A. Fraser, has provided an opening statement to the 2016-17 Budget Estimates session of the Senate Economics Legislation Committee. In the statement he discusses weak inflation, prospective economic growth across the states, and the litany of global economic risks, including from a slowing China, financial markets, and low inflation. The fact is that global economic conditions continue to be challenging. Finally, he speaks to the 10 year costs of the budget plan to cut company tax over 10 years and lifting the small business threshold.

In essence, the Budget forecasts indicate that the Australian economy continues to transition from mining investment-led growth to broader-based growth. But real GDP growth is forecast to be below potential over the next two years at 2½ per cent in 2015-16 and 2016-17 and then strengthen to 3 per cent in 2017-18 as the detraction from falling mining investment eases. Over the following two years, real GDP is projected (not forecast) to increase by 3 per cent per annum.

The economy is already benefiting from rapidly rising mining export volumes and this is set to continue as more LNG export capacity comes on line. Mining export volumes are expected to increase by more than 20 per cent over the forecast period.

In the midst of this transition and as noted at our most recent Hearing, the labour market has been remarkably resilient. The labour market has performed better than expected at 2015‑16 MYEFO. Employment growth has been supported by moderate wage growth and the transition to more labour-intensive sectors of the economy.

Inflation outcomes so far appear to have been weaker than forecast in the 2015‑16 MYEFO. Consumer price inflation in the March 2016 quarter showed broad‑based weakness that was reflected in the very weak underlying inflation outcome. In that context, the Reserve Bank Board decided to reduce the cash rate by 25 basis points to 1.75 per cent, the lowest setting on record.

Reports from across Australia indicate that activity in New South Wales and Victoria remain strongest, while activity in Tasmania has also picked up. The Northern Territory and the Australian Capital Territory are performing reasonably well and Queensland is performing better than expected a year ago supported by a pick-up in construction activity around Brisbane. South Australia continues to remain soft, and there are clear signs that activity in Western Australia is weaker than expected.

Globally, growth is forecast to be weaker than 2015-16 MYEFO. The United States has had a slow start to the year but there are tentative signs of a pick-up in Europe. China’s growth continues to moderate, but remains relatively strong compared with most other major economies.

I want to focus my comments today on the risks to the global outlook.

Risks to the global growth outlook are present in both advanced and emerging market economies as global uncertainties increase. This message was made clear at the latest meeting of the G20 Finance Ministers and Central Bank Governors in April where the outlook for growth was assessed to remain modest and uneven.

As also noted previously, significantly for Australia are the uncertainties around the implications of the transition in the Chinese economy from investment-led to consumption and services-led growth given the exposure of Australia and its major trading partners to China. And while China’s economic transition is expected to contribute to more sustainable growth over the longer term, Chinese domestic consumption and a growing service sector is unlikely to fully offset the decline in investment and a slowing industrial sector in the near and medium term.

There will be opportunities for Australia in this transition. Our past trade has predominantly been focused on demand for our commodities. Trade with China as it transitions to a consumer-led economy will be more focused on demand for our services. We also expect a growing investment relationship with China, building off a strong base and further boosted by the China-Australia Free Trade Agreement.

A sharper than expected slowdown in Chinese growth, however, would have significant implications for our economy and the region. This is because China is Australia’s number one export market and import supplier. Globally, China is one of the main trading partners for more than 100 economies which account for about 80 per cent of world GDP; so a slowing China will have far reaching effects around the world.

There are risks of renewed volatility in financial markets, which we saw earlier this year. That volatility can reflect concerns in equity and credit markets as to whether the outlook for current global growth will be strong enough to drive corporate earnings and maintain low default rates in order to sustain current valuations. Such bouts of volatility have adversely impacted the financial conditions faced by businesses and households in key global economies.

Banks globally also continue to hold more capital than they did prior to the global financial crisis. However, a number of major economies continue to face financial challenges, particularly the euro area, Japan and a range of emerging market economies. Significant debt has been raised in recent years, particularly in emerging markets, which could also create challenges for both borrowers and lenders in a continued low global growth environment.

Inflation remains low globally reflecting, in part, the impact of low energy costs. I expect inflation in major advanced economies to remain below policy targets for at least in the near term and monetary policy in major advanced economies to remain accommodative for some time yet. Significantly, expectations for further US Federal Reserve rate rises have been pushed out a little.

There is also the risk that low inflation, coupled with low wages growth and low productivity growth experienced in many advanced economies, could become embedded in lower potential growth over time.

Estimates for long-run potential global growth are also being reconsidered by official forecasters. This partly reflects the ongoing legacy of the global financial crisis which has had long lived effects on investment in productive capital and on labour markets. In advanced economies, potential growth was slowing even before the global financial crisis.

Contributing to low productivity growth and declining potential growth is the significant transition underway in global demographic conditions. The global population is growing more slowly, and as fertility rates fall and people live for longer, populations are growing older. A number of countries — including Japan, China and Germany — are confronting declining working age populations.

There is also uncertainty about the effect of oil prices on global growth. This is because the response to lower oil and energy prices in 2015 has not been as strong as might be expected based on historical experience. Factors likely to have muted the positive net impact of lower oil prices on global growth include lower global energy investment and a smaller than expected increase in global private consumption, perhaps as consumers save part of the windfall from lower oil prices.

In summary, it is all uncertain. The Budget shows that the Australian economy continues to transition from mining investment-led growth to broader-based growth. As a still relatively small, open economy, global economic conditions are very important to Australia’s economic outlook. The fact is that global economic conditions continue to be challenging.

On another matter, Treasury standard practice is not to release costings beyond the forward estimates or for the medium term. On this occasion, the Treasurer has authorised me to provide to the Committee the medium-term estimate of the cost to the budget of lifting the small business entity threshold and reducing the company tax rate to 25 per cent by 2026-27. The cost of these measures to 2026-27 is $48.2 billion in cash terms. These estimates have been incorporated into the budget’s medium-term projections for tax receipts. I note that, as with all tax projections over 10 years, these costings have considerable uncertainty. I also note that the medium term economic projections in the Budget assume significant ongoing economic reforms. Finally, I note that Treasury has estimated that the Government’s tax package is estimated to increase the level of GDP by a little over 1 per cent in the long term.

Proposed Financial Institutions Supervisory Levies For 2016-7

The financial industry levies are set to recover the operational costs of APRA and other specific costs incurred by certain Commonwealth agencies and departments, including the Australian Securities and Investments Commission, the Australian Taxation Office, and the Department of Human Services. ASIC gets a 150% uplift, reflecting the requirement for greater supervision of across financial services.

The Treasury has released a paper, prepared in conjunction with the Australian Prudential Regulation Authority (APRA), seeking submissions on the proposed financial institutions supervisory levies that will apply for the 2016-17 financial year by  Friday, 3 June 2016.

LeveyHere they are itemised by industry segment.

Levey1Australian Securities and Investments Commission component

A component of the levies is collected to partially offset ASIC’s regulatory costs in relation to consumer protection, financial literacy, regulatory and enforcement activities relating to the products and services of APRA regulated institutions as well as the operation of the Superannuation Complaints Tribunal (SCT). In addition, the levies are used to offset the cost of a number of Government initiatives including the over the counter (OTC) derivatives market supervision reforms and ASIC’s MoneySmart programmes.

$70.4 million will be recovered to offset ASIC regulatory costs through the levies in 2016-17. This amount is 150.1 per cent more than in 2015-16 as a consequence of the Government’s decisions to provide funding to the SCT to deal with legacy complaints and improve processes and infrastructure ($5.2 million) and to bolster ASIC to protect Australian consumers ($37.0 million).

As part of the improving outcomes in financial services package, the Government will:

  • invest $61.1 million over four years to enhance ASIC’s data analytics and surveillance capabilities as well as modernise ASIC’s data management systems;
  • provide ASIC with $57.0 million over four years to enable increased surveillance and enforcement in the areas of financial advice, responsible lending, life insurance and breach reporting; and
  • accelerate the implementation of a number of key measures recommended by the Financial System Inquiry.

From 2017-18 onwards, ASIC’s regulatory costs will be recovered from all industry sectors regulated by ASIC. The Government will consult extensively with industry to refine and settle an industry funding model for ASIC.

Australian Taxation Office component

Funding from the levies collected from the superannuation industry includes a component to cover the ATO’s regulatory costs in administering the Superannuation Lost Member Register (LMR) and Unclaimed Superannuation Money (USM) frameworks. In 2016-17, it is estimated that the total cost to the ATO in undertaking these functions will be $17.8 million, with the full amount to be recovered through the levies in line with the requirements of the Government’s Charging Framework.

The majority of this funding supports the ATO’s activities, which include:

  • the implementation of strategies to reunite individuals with lost and unclaimed superannuation money including promotion of the ATO On Line Individuals Portal and targeted SMS/e mail campaigns;
  • working collaboratively with funds to engage members being reunited with their super, including Super Match and providing funds with updated contact information about their lost members;
  • processing of lodgements, statements and other associated account activities;
  • processing of claims and payments, including the recovery of overpayments;reviewing and improving the integrity of data on the LMR and in the USM system; and
  • reviewing and improving data matching techniques, which facilitates the display of lost and unclaimed accounts on the ATO On Line Individuals Portal.

The funding also supports the ongoing upkeep and enhancement of the ATO’s administrative system for USM frameworks and the LMR, and for continued work to improve efficiency and automate processing where applicable.

Department of Human Services component

The Department of Human Services administers the Early Release of Superannuation Benefits on Compassionate Grounds programme (ERSB). The compassionate grounds enable the Regulator (the Chief Executive of Medicare) to consider the early release of a person’s preserved superannuation in specified circumstances.

The volume of ERSB applications has significantly increased since it was made possible to apply online. In 2015-16, the ERSB received 27,688 applications. This was a 44 per cent increase compared with the previous year. In 2016-17, the ERSB is forecast to receive approximately 38,763 applications. This will represent an approximate increase in volume of 40 per cent compared with the previous year.

The programme is expected to cost the Government $4.8 million in 2016-17. In line with the Government’s Charging Framework, this amount will be recovered in full through the levies.

SuperStream component

Announced as part of the former Government’s Stronger Super reforms, SuperStream is a collection of measures that are designed to deliver greater efficiency in back-office processing across the superannuation industry. Superannuation funds will benefit from standardised and simplified data and payment administration processes when dealing with employers and other funds and from easier matching and consolidation of superannuation accounts. The costs associated with the implementation of the SuperStream measures are to be collected as part of the levies on superannuation funds. The levies will recover the full cost of the implementation of the SuperStream reforms and are to be imposed as a temporary levy on APRA-regulated superannuation entities from 2012-13 to 2017-18 inclusive.

The costs associated with the implementation of the SuperStream reforms are estimated to be $35.5 million in 2016-17 and $32.0 million in 2017-18.

Morrison warns banks not to pass on new ‘user-pays’ impost to finance ASIC reform

From The Conversation.

Treasurer Scott Morrison has warned Australian banks not to pass on to customers the $121 million user-pays charge imposed on them to finance a strengthened Australian Securities and Investments Commission (ASIC).

The banks will pay for almost all the $127 million four-year package, which the government hopes will take the sting out of Labor’s promise that it would set up a royal commission.

But Opposition Leader Bill Shorten said the issues were not just matters of the law but the culture.

The government will provide $61.1 million to boost ASIC’s technology to boost its surveillance capabilities. “In the 21st century economy, you need a tech cop on the beat,” Morrison said.

Another $9.2 million will go to ASIC and Treasury to ensure they can implement appropriate law and regulatory reform.

ASIC will get a further $57 million for the ongoing cost of increased surveillance and enforcement in the areas of financial advice, responsible lending, life insurance and breach reporting.

The measures follow a capability review of ASIC initiated by the government in July.

Among other changes, an extra ASIC commissioner will be appointed with experience in the prosecution of crimes in the financial services industry.

The government is accelerating the implementation of recommendations from the Murray review of the financial system for increased penalties and greater powers for ASIC to intervene on financial products.

ASIC’s employment practices will be exempted from the public service act, so it can recruit from the market people with experience in the sector.

The government will recommend that the financial services ombudsman changes its thresholds to provide greater access for treatment of claims and compliance.

An “eminent panel” will examine bringing together forums to have a “one stop shop” for consumer complaints.

Morrison told a joint news conference with Assistant Treasurer Kelly O’Dwyer that the banks would pay an additional $121 million to increase the resources of ASIC.

ASIC would also be moved to a full user-pays funding model. “No longer will it be the case that taxpayers will be hit to fund this regulator, this enforcement authority, this cop on the beat. Those whom it’s enforcing the regulations and rules on, will pay the price for that,” he said.

Asked whether the banks would not just pass on the impost in higher fees and charges, Morrison said the levies were “easily digestible by the banks”. He would be “furious” if the banks sought to pass the cost on and they had that message from him.

The term of ASIC chairman Greg Medcraft, which is expiring, has been extended – but only for 18 months to oversee the implementation of the reforms.

Making his pitch for reforming ASIC rather than having a royal commission, Morrison said: “What I have outlined today is a serious action plan. … This is what practical, effective targeted government looks like and that’s how we are responding to these issues of real concerns to Australians.”

He said Shorten “wants to spend your money to fund his political exercise which won’t get outcomes for people – it will just get a political outcome for Bill Shorten”.

O’Dwyer denied that the government previously tried to wind back consumer protections in the financial sector. “That’s simply not correct,” she said.

The Abbott government introduced regulations to water down the Labor government’s Future of Financial Advice (FOFA) reforms. But later these were disallowed by the Senate.

Shadow treasurer Chris Bowen said the package was “nothing more a political fix” to try to avoid a royal commission. “It’s a plan to hobble through an election.”

Responding to the government’s announcement Westpac said “The measures announced today by the government will play an important role in ensuring customers can be confident in our banking system.

“In line with our submission to the financial system inquiry, Westpac supports a user pays model for ASIC.”

Australian Bankers’ Association chief executive Steven Münchenberg said: “We support the introduction of a new industry funding model for ASIC” adding that it was “important that contributions are transparent and that the amount of fees levied matches the level of regulation and resources required for ASIC”.

He said that the banking industry supported, in principle, the product intervention power for ASIC to bolster consumer protections. “However, we need to be wary of any action that may have unintended consequences and adversely impact on product innovation or consumer choice.”

Author: Michelle Grattan, Professorial Fellow, University of Canberra

Small Amount Credit Review Recommends Tighter Controls

The final report of the Review of Small Amount Credit Contracts (SACCs) has been released. A range of recommendations tighten regulation of short term small loans and consumer leases. Of note is the need to disclose the actual APR of the transaction, be it a small amount credit contract or consumer lease. In the latter case, the cost of the relevant household good must be disclosed.

The review panel provided the Final Report to the Government on 3 March 2016.

The review was silent on mandating better collection of transaction data so  the true volume of loans could be recorded. As highlighted in the report accurate data is an issue.

Small Amount Credit Contracts (SACCs)

Recommendation 1 – Affordability – Extend the protected earnings amount regulation to cover SACCs provided to all consumers.
Reduce the cap on the total amount of all SACC repayments (including under the proposed SACC) from 20 per cent of the consumer’s gross income to 10 per cent of the consumer’s net (that is, after tax) income. Subject to these changes being accepted, retain the existing 20 per cent establishment fee and 4 per cent monthly fee maximums.
Recommendation 2 – Suitability – Remove the rebuttable presumption that a loan is presumed to be unsuitable if either the consumer is in default under another SACC, or in the 90-day period before the assessment, the consumer has had two or more other SACCs.
This recommendation is made on the condition that it is implemented together with Recommendation 1.
Recommendation 3 – Short term credit contracts – Maintain the existing ban on credit contracts with terms less than 15 days.
Recommendation 4 – Direct debit fees – Direct debit fees should be incorporated into the existing SACC fee cap.
Recommendation 5 – Equal repayments and sanction – In order to meet the definition of a SACC, the credit contract must have equal repayments over the life of the loan (noting that there may need to be limited exceptions to this rule). Where a contract does not meet this requirement the credit provider cannot charge more than an annual precent rate (APR) of 48 per cent.
Recommendation 6 – SACC database – A national database of SACCs should not be introduced at this stage. The major banks should be encouraged to participate in the comprehensive credit reporting regime at the earliest date.
Recommendation 7 – Early repayment –  No 4 per cent monthly fee can be charged for a month after the SACC is discharged by its early repayment. If a consumer repays a SACC early, the credit provider under the SACC cannot charge the monthly fee in respect of any outstanding months of the original term of the SACC after the consumer has repaid the outstanding balance and those amounts should be deducted from the outstanding balance at the time it is paid.
Recommendation 8 – Unsolicited offers – SACC providers should be prevented from making unsolicited SACC offers to current or previous consumers.
Recommendation 9 – Referrals to other SACC providers – SACC providers should not receive a payment or any other benefit for a referral made to another SACC provider.
Recommendation 10 – Default fees – SACC providers should only be permitted to charge a default fee that represents their actual costs arising from a consumer defaulting on a SACC up to a maximum of $10 per week. The existing limitation of the amount recoverable in the event of default to twice the adjusted credit amount should be retained.

Consumer Leases

Recommendation 11 – Cap on cost to consumers – A cap on the total amount of the payments to be made under a consumer lease of household goods should be introduced. The cap should be a multiple of the Base Price of the goods, determined by adding 4 per cent of the Base Price for each whole month of the lease term to the amount of the Base Price. For a lease with a term of greater than 48 months, the term should be deemed to be 48 months for the purposes of the calculation of the cap.
Recommendation 12 – Base Price of goods – The Base Price for new goods should be the recommended retail price or the price agreed in store, where this price is below the recommended retail price. Further work should be done to define the Base Price for second hand goods.
Recommendation 13 – Add-on services and features – The cost (if any) of add-on services and features, apart from delivery, should be included in the cap. A separate one-off delivery fee should be permitted. That fee should be limited to the reasonable costs of delivery of the leased good which appropriately account for any cost savings if there is a bulk delivery of goods to an area.
Recommendation 14 – Consumer leases to which the cap applies – The cap should apply to all leases of household goods including electronic goods.
Further consultation should take place on whether the cap should apply to consumer leases of motor vehicles.
Recommendation 15 –Affordability – A protected earnings amount requirement be introduced for leases of household goods, whereby lessors cannot require consumers to pay more than 10 per cent of their net income in rental payments under consumer leases of household goods, so that the total amount of all rental payments (including under the proposed lease) cannot exceed 10 per cent of their net income in each payment period.
Recommendation 16 – Centrepay implementation – The Department of Human Services consider making the caps in Recommendations 11 and 15 mandatory as soon as practicable for lessors who utilise or seek to utilise the Centrepay system.
Recommendation 17 – Early termination fees – The maximum amount that a lessor can charge on termination of a consumer lease should be imposed by way of a formula or principles that provide an appropriate and reasonable estimate of the lessors’ losses from early repayment.
Recommendation 18 – Ban on the unsolicited marketing of consumer leases – There should be a prohibition on the unsolicited selling of consumer leases of household goods, addressing current unfair practices used to market these goods.

Combined recommendations

Recommendation 19 – Bank statements – Retain the obligation for SACC providers to obtain and consider 90 days of bank statements before providing a SACC, and introduce an equivalent obligation for lessors of household goods. Introduce a prohibition on using information obtained from bank statements for purposes other than compliance with responsible lending obligations. ASIC should continue its discussions with software providers, banking institutions and SACC providers with a view to ensuring that ePayment Code protections are retained where consumers provide their bank account log-in details in order for a SACC provider to comply with their obligation to obtain 90 days of bank statements, for responsible lending purposes.
Recommendation 20 – Documenting suitability assessments – Introduce a requirement that SACC providers and lessors under a consumer lease are required at the time the assessment is made to document in writing their assessment that a proposed contract or lease is suitable.
Recommendation 21 – Warning statements – Introduce a requirement for lessors under consumer leases of household goods to provide consumers with a warning statement, designed to assist consumers to make better decisions as to whether to enter into a consumer lease, including by informing consumers of the availability of alternatives to these leases. In relation to both the proposed warning statement for consumer leases of household goods and the current warning statement in respect of SACCs, provide ASIC with the power to modify the requirements for the statement (including the content and when the warning statement has to be provided) to maximise the impact on consumers.
Recommendation 22 – Disclosure – Introduce a requirement that SACC providers and lessors under a consumer lease of household goods be required to disclose the cost of their products as an APR. Introduce a requirement that lessors under a consumer lease of household goods be required to disclose the Base Price of the goods being leased, and the difference between the Base Price and the total payments under the lease.

The Government is also consulting on whether the recommendations relating to consumer leases should apply to all regulated consumer leases (including motor vehicles) rather than only leases of household goods, and how second hand goods should be treated.

Life Insurance Remuneration Reform Regulations

The Government has released draft regulations that will support the Government’s life insurance reform package to better align the interests of financial firms with consumers.

Remuneration relating to life insurance advice provided outside of superannuation was excluded from the ban on conflicted remuneration (remuneration likely to influence advice) introduced under the Future of Financial Advice (FOFA) laws.

A series of reports, including a review the Australian Securities and Investments Commission (ASIC), the industry-commissioned Trowbridge Report and the Financial System Inquiry (FSI), identified the need to better align the interests of providers of financial advice in the life insurance sector with consumer outcomes. As part of its response to the FSI, the Government announced that it would support a reform package put forward by industry.

The reform package introduced by the Life Act removes the exemption from the ban on conflicted remuneration, and introduces caps under which commissions will be permitted to be paid, as well as arrangements to ‘clawback’ commissions where policies lapse in the first two years. The reforms will commence on 1 July 2016.

The Regulation supports the reform package introduced by the Life Act by:

  1. allowing the temporary inclusion of stamp duty relating to death benefits to be included in commission calculations while industry update its information technology systems;
  2. prescribing circumstances where ‘clawback’ does not apply, such as in situations where a policy is cancelled automatically due to the age of the insured or where a premium rebate is offered to encourage customers to take up a policy; and
  3. ensuring that existing life insurance remuneration arrangements are grandfathered in a manner broadly consistent with FOFA by ensuring that remuneration arrangements not effectively grandfathered by the Life Act
    (i.e. employee-employer remuneration arrangements) are explicitly grandfathered in the Regulation. Grandfathering means that the existing rules continue to apply to existing arrangements, while new rules apply to new arrangements.

Closing date for submissions: Thursday, 28 April 2016

Forecasting Ain’t Easy

Warren Tease, Principal Adviser, Macroeconomic Conditions Division spoke at CEDA’s Economic and Political Overview Conference about forecasting in Treasury.

Most forecasts for growth in most economies have been persistently too high over the past few years.

In that time, a key feature of the forecasts for the global economy and for Australia has been the persistent downgrading of forecasts. The pattern of downgrades is clear. In almost every year since the crisis, forecasters have been too optimistic about the outlook for growth. Treasury’s forecasts have exhibited the same behaviour. This persistent bias is perhaps the most unusual attribute of recent experience, at least in Treasury’s case, as past forecasting reviews have shown that Treasury’s real GDP forecasts have not exhibited persistent errors over time.

Digging a little deeper into this quantitative work I would also observe that Treasury’s forecasts did well in normal times but were challenged when conditions were unusual.

Thus, while there was no evidence of persistent errors over a very long time period, Treasury’s forecasts were punctuated by persistent and sometimes large errors over horizons relevant for policy makers and their advisers.

This can be seen in the following chart which compares Treasury’s forecasts of nominal GDP growth with actual outcomes since the early 1990s. I use nominal rather than real GDP as it is a key input into forecasting budget outcomes.

Chart 2 — Nominal GDP Forecasts and Outcomes

Source: Budget papers and ABS cat. no. 5206.0

It shows three distinct periods of forecast errors. Forecasts regularly overestimated nominal GDP growth in the early 1990s and after the financial crisis while understating outcomes for most of the 2000s prior to the crisis.

Each of these episodes coincided with Treasury persistently erring in its inflation (measured by the GDP deflator) forecasts. This observation has been made in each of the previous forecast reviews.

As previous reviews noted Treasury missed the decline in inflation in the early 1990s.

More recently, the forecasts did not incorporate fully the impact of the unprecedented rise then fall of commodity prices. In the upswing, Treasury’s forecasts did include projections that prices would eventually fall but these proved to be wrong as prices continued to increase. In the downswing, prices have fallen more rapidly than Treasury’s assumptions implied. Heightened volatility in Australia’s terms of trade has made it more difficult to forecast nominal GDP outcomes.

While difficulty in forecasting the GDP deflator has been a feature of Treasury’s (and others’) forecasts, past reviews have shown that its real GDP forecasts were more accurate and unbiased. Therefore, it is the persistent errors in Treasury’s real GDP forecasts of the past few years that have been unusual.

The chart shows that in the 1990s and 2000s there was no distinct under or overestimate in Treasury’s forecasts for the real economy. However, since the crisis Treasury, like the other forecasters presented earlier, has for the most part overestimated real GDP growth.

Chart 3 Real GDP Forecasts and Outcomes

Source: Budget papers and ABS cat. no. 5206.0

Now I do not wish to push this point too hard as the sample set is very small but it is consistent with what we are seeing across a range of forecasters and countries.

He has reviewed the forecasting approach, and concluded that in Australia a smaller number of input metrics have been used, compared with other countries. In addition Australia, as an open economy is wide open to international factors which impact locally.

“For a small open economy like Australia, persistent and short-term deviations from trend are likely to be driven by global economic shocks, large changes in commodity prices or from the financial sector. Other factors could also be important but these three factors encompass much of Australia’s experience with shocks.”

Finally, there is a bias towards trend performance, so any deviation is harder to cope with.

“It means that Treasury’s forecasting approach is likely to generate reliable forecasts at times when economic conditions are normal but will be challenged at other times.

There is a therefore a high probability that structural changes or persistent shocks will not be adequately incorporated into the forecasts”.

Good to see a discussion about the complexity of forecasting in a volatile environment. We should not be taking their projections as gospel truth. Forecasting ain’t easy!

Government Consults On Tax Incentives For Early Stage Investors

A cornerstone of this consultation is the definition of an innovation company. The Government is keen to hear from stakeholders on the appropriate definition of an innovation company and how the eligibility principles and criteria can leverage off existing industry concepts and business practices.

On 7 December 2015, the Government announced the National Innovation and Science Agenda (NISA), including new tax incentives for early stage investors.

The tax incentives will provide concessional tax treatment for investors through a non-refundable tax offset and a capital gains tax (CGT) exemption on investments that meet certain eligibility criteria.

The tax incentives are designed to encourage investment into Australian innovation companies (innovation companies) at earlier stages, where a concept has been developed, but the company may have difficultly accessing equity finance to assist with commercialisation. Separate initiatives have been announced relating to investment at later stages, including reforms to early stage venture capital limited partnerships (ESVCLP) and venture capital limited partnerships (VCLP). These separate reforms will apply from the 2016-17 income year.

The tax incentives for early stage investors measure is being developed in a way that is cognisant of these different stages of financing and the availability of other initiatives specifically targeted at companies at a later stage of development. The Government is mindful that innovation companies beyond a certain size should still be able to benefit from Australia’s existing venture capital regime.

The approach taken for the incentives has been informed by the work of other jurisdictions including the United Kingdom and Singapore, however the approach that has been developed is specific to the Australian economy and adapted to suit the Australian tax system. The Government is developing a principles-based approach to the design of the legislation for this measure that will help to ensure that the incentives continue to encourage investment into the future as technologies and business activities change.

OVERVIEW OF THE NEW TAX INCENTIVES

These incentives will provide eligible investors with a 20 per cent non-refundable tax offset for the amount paid for newly issued shares in an innovation company, where the amount is paid either directly to the innovation company or indirectly through a qualifying innovation fund. An investor can invest in innovation companies; innovation funds; or into both. As the offset is non-refundable, it will only be of immediate benefit where the investor has a tax liability. However, where an investor cannot use the tax offset in the relevant income year they may carry it forward to use in a future year. The tax offset will be available to both residents and non-residents.

There are a number of ways to define an innovation company. Adopting a principles-based approach will provide a conceptual framework and ongoing flexibility. This, in turn, will be supported by specific eligibility criteria (safe harbours or gateway criteria) to provide greater certainty for potential investors and innovation companies. It is also anticipated that specific exclusions will apply to activities that do not align with the policy intent of the tax incentives.

An eligible innovation company must meet the following criteria:
• was incorporated in Australia during the last three income years;
• had assessable income of $200,000 or less in the prior income year;
• had expenditure of $1 million or less in the prior income year; and
• is not an entity listed on any stock exchange.

Investors will receive a non-refundable tax offset of up to $200,000 (on an affiliate-inclusive basis) for investments (direct or indirect) in eligible innovation companies in an income year. This means that for investments up to $1 million, investors receive the full 20 per cent non-refundable tax offset. Where the offset is carried forward and further eligible investments are made, the offset that may be claimed in any one year is capped at $200,000. Investment amounts greater than $1 million in an income year do not increase the amount of the offset available. Investments over $1 million still benefit from exempt capital gains, see below. The cap applies on an affiliate-inclusive basis in order to prevent entities entering into arrangements to circumvent the cap.

In addition to receiving a tax offset, investors (including a qualifying innovation fund) will not pay any CGT on gains from the disposal of shares in an innovation company provided those shares are held for at least three years. This applies to both resident and non-resident investors.

Where shares are held for more than 10 years, any incremental gain in value after 10 years will be subject to CGT and deemed to be on capital account. In this situation, the entity receives a first element of the cost base (or reduced cost base) equal to the market value calculated on the tenth anniversary of the date of acquisition.

Capital losses will be unavailable for shares issues as part of these tax incentives for early stage investors. In place of capital losses, immediate tax offsets are available subject to the income year offset cap. In order to achieve this result, the investor will initially treat the acquired shares as having a CGT reduced cost base of nil.

Closing date for submissions: Wednesday, 24 February 2016

The Budget Conundrum

John Fraser’s speech yesterday as Secretary to the Treasury, is significant because it does highlight some of the key issues driving future economic outcomes, and even our credit rating.

“The clear message is that we cannot rely on any cyclical bounce to reduce outlays as a percentage of GDP or, for that matter, the deficit. We are not in a crisis. But the Budget is rightly a focus of attention”.

“We have a structural budget problem that arose before the global financial crisis. A very substantial amount of the revenue windfall was used to lock-in long-term spending commitments”.

“Much of the deterioration in the budget position has been the result of revenue collections falling short of forecasts as we experience the flipside of the mining investment boom”.

“As a result, at 25.9 per cent of GDP, spending in 2015 16 is forecast to be close to the post-GFC peak, and could have been higher were it not for the measures taken by the Government in MYEFO”.”The Commonwealth’s interest bill has reached over a billion dollars a month. This is projected to more than double within the decade, unless action is taken to improve our budgetary position”.

“The Commonwealth achieving surpluses means that the States can run small overall deficits that they can use to finance productive infrastructure investment. This was a key conclusion of the 1993 National Savings Report commissioned by the then Treasurer, John Dawkins. In my view, this is still a sound framework for thinking about fiscal policy today. The rising structural deficits and debt give rise to intergenerational issues”.

“Around two-thirds of Commonwealth public debt is held by non-resident investors. This share has risen since 2009 and remains historically high. This, if anything, leaves Australia’s fiscal position a little more exposed to shocks in global capital markets”.

“It’s important that Australia maintain its top credit ratings, which helps to contain the costs associated with servicing public debt. Australia is one of only ten countries with a triple A credit rating from all three of the major rating agencies, reflecting our reputation for fiscal prudence”.

“But there have also been a number of policy decisions over recent years that have pushed the ratio higher: including increasing base pensions and supplementary payments, increased Defence operations and border protection spending, expenditure related to the carbon compensation package and the outcomes of negotiations around the repeal of the Minerals Resource Rent Tax. And the Government continues to face spending pressures”.

“There are many worthwhile spending programs and, every year, there are more good ideas than government resources to support them. There is also often, a mismatch between what the community expects the government to support and what they are prepared to pay for either in tax or in user charges. In framing budgets, we are really asking ourselves now and in the longer term what sort of society we want to have”.

“The ageing of Australia’s population will weigh heavily on Australia’s potential growth rate and long-term fiscal position. Demographic and broader medium-term pressures will place greater demands on government finances, making deficit and debt reduction more difficult”.

“Structural reform is critical and this includes reforming competition policy and implementing the Harper Review recomendations”.

“Improving productivity is a far more sustainable way to boost economic growth than relying unduly on an exchange rate depreciation”.

“These growth-enhancing policies also very much include tax reform. Tax is not just about raising revenue, it is also about helping to shape the economy so that we attract and deploy resources in a manner to promote long term growth. The arguments for a tax mix switch rest heavily on encouraging more jobs through a higher growth path. Tax reform is a complex issue and is very much the focus of the Government at the current time”.