Tag: Treasury

FactCheck: was Australia on a debt trajectory heading to 122% of GDP?

From The Weekend Conversation:

“given we inherited a trajectory of debt and deficit heading to 122% of GDP, which was the Greek-like proportions the Prime Minister talked about. We have halved, just through our legislated measures, we have halved that trajectory. So now we are heading towards just above 50% of net debt to GDP. – Assistant Treasurer Josh Frydenberg, interview with Fran Kelly on RN Breakfast, March 26, 2015″.

Mr Frydenberg and other Abbott government ministers have, on several occasions, told voters their measures have trimmed a debt and deficit trajectory heading to 122% of GDP down to just above 50%.

But where do those numbers come from and how much credence should we place in them?

The Intergenerational Report

When asked for a source for those numbers, a spokesperson for Mr Frydenberg directed The Conversation to the Intergenerational Report, released by Treasury in early March, in particular Chapter 2, which states under section 2.1.3 Balance Sheet that:

Under the “previous policy” scenario, net debt is projected to reach 122% of GDP in 2054–55. This represents $5,559 billion in today’s dollars and is equal to $139,900 per person (Chart 2.4). The projected level of Australian Government debt is significantly improved under the “currently legislated” scenario. Net debt is projected to reach 57.2% of GDP in 2054–55 ($2,609 billion in today’s dollars) under the “currently legislated” scenario.

Remember, the debt in question here is domestic currency debt accumulated by government due to budget deficits (where government spending has exceeded tax revenue). It’s not about debt owed by Australians to foreigners which is denominated in foreign currency. Nor are we referring to private debt owed by businesses and households. (Australia’s foreign debt is very low, and even smaller is government foreign debt. Private debt is obviously very large but rarely highlighted as a concern, even though that was a major issue for the US in the GFC).

So the Assistant Treasurer has accurately quoted figures from the Intergenerational Report, which forecast that Australia was on a trajectory to reach debt worth 122% of GDP in 2054-55.

However, while he’s been accurate in quoting it, a number of economists regard the figures in the Intergenerational Report as problematic and politicised.

Treasurer Joe Hockey has rejected claims that the report is a political document, saying:

Some will claim it’s a political document. So be it… But the numbers and the trends are there, whether it’s the Liberal party, the National party, the Labor party, the Greens or Palmer United, the fact is the trends are still there.

Uncertainties

There is a significant random element to budgets, which naturally governments treat opportunistically. For instance, the surpluses under the earlier Howard government were largely due an inflow of revenue from the mass privatisations of assets in the 1990s.

To begin with, any forecast 40 years ahead is fraught with uncertainty. Another problem with long term predictions is that very small changes in figures attached to factors under consideration, when compounded, induce large changes in the projections. Minor tweaks to economic models can have major consequences when projected 40 years into the future.

For example, a PwC report released in July 2013 estimated that the Australian governments’ debt levels as a proportion of GDP will rise to 77.9% by 2049-50 – a significantly different scenario that shows that different economic models can produce vastly different results when projected over long time periods.

The Intergenerational Report’s Appendix C on methodology refers to a wide range of assumptions made about demographic changes but some of those assumptions have been criticised by other economists, like the University of Queensland’s John Quiggin.

The report says on page 111 that “various models that produce the projections are under the guidance of a senior Treasury steering committee designed to ensure internal consistency and legitimacy of assumptions.”

But it is not clear if these models factor in the costs of reduced government spending on health, education and the environment. For instance, if the health budget is cut, hospital admissions and workdays lost would increase, in turn affecting economic activity.

Debating debt

The background – and highly politicised – question behind all of this is: how worried should we be about government debt?

On one side of that debate are those who take what has been called a neoliberal position. They are concerned that government activity funded by borrowing will raise interest rates and crowd out private business activity, which is viewed as more efficient.

On the other side are Keynesian economists, who argue that governments may need to run budget deficits – especially in times of downturn, like the GFC. Such budget deficits will be cancelled out when the economy consequently improves and unemployment falls, they say, because the tax take will increase and welfare payouts will fall. In addition, government spending on infrastructure and research and development would support the growth of industry, they argue, hence a certain amount of government debt is necessary.

In fact, debt has been remarkably variable and volatile over time and across countries with very differing levels of development and patterns of economic growth. Debt is influenced by a large range of factors, including economic growth and inflation.

Verdict

Mr Frydenberg’s quote that “we inherited a trajectory of debt and deficit heading to 122% of GDP.. [and] just through our legislated measures, we have halved that trajectory” is an accurate reflection of the findings of the Intergenerational Report. However, without more detail on how the authors of the report arrived at that figure of 122%, it is not possible to say if it is true or not. And while Mr Frydenberg has been accurate in quoting it, the report’s modelling has been criticised by a number of economists.

Review

The FactCheck is clearly correct in finding that Mr Frydenberg’s statement accurately reflected the estimates of the Intergenerational Report 2015.

However, Mr Frydenberg’s statement referred to the “trajectory” that the government inherited. The “previous policy” scenario of the Intergenerational Report was not “inherited” – it includes substantial budgetary drags due to Abbott Government policies. The “previous policy” scenario of the Intergenerational Report is based on the 2013-14 MYEFO figures, which amongst other changes from the Labor government’s policies, assume the abolition of the Carbon and Mining taxes, and the creation of a paid parental leave scheme.

The Intergenerational Report assumes that a number of welfare payments will decline substantially relative to average wages, that health spending will grow much more slowly over the next decade than the last, and that governments will cut income taxes even when deficits and debt are rapidly increasing.

In analysing concerns about debt, it is worth noting that if governments fund services today with borrowing, they effectively ask taxpayers of future years to pay for them through higher taxes and lower living standards than they would enjoy otherwise. Although there are academic debates about whether budget impacts are mitigated through changed consumer behaviour or inheritances, the intergenerational transfer of budget deficits (sometimes labelled as “intergenerational theft”) is often cited as a reason to avoid increasing government debt. – John Daley, Chief Executive Officer at Grattan Institute.

Have you ever seen a “fact” that doesn’t look qu

A New Tax System for Managed Investment Trusts

The Treasury released an exposure draft today. The proposed new tax system for managed investment trusts (MITs) will modernise the tax rules for eligible MITs and increase certainty for both MITs and their investors. The new rules will enhance the international competitiveness of Australian managed funds and promote the greater export of Australia’s funds management expertise.

The exposure draft legislation has been developed in close consultation with key stakeholders in the managed funds industry.

The key features of the new tax system for eligible MITs include:

  • an attribution model for determining member tax liabilities, which allows amounts to retain their tax character as they flow through a MIT to its members;
  • the ability to carry forward understatements and overstatements of taxable income, instead of re-issuing investor statements;
  • deemed fixed trust treatment under the income tax law;
  • upwards cost base adjustments to address double taxation; and
  • legislative certainty about the treatment of tax deferred distributions.

Reforms To Offshore Banking Units

On 6 November 2013, the Government announced that it would proceed with certain reforms to the Offshore Banking Unit (OBU) regime.These reforms address a number of integrity concerns with the existing regime while ensuring the OBU regime targets mobile financial sector activity. They are now seeking input on proposed changes. Consultation closes for submissions on Wednesday, 8 April 2015

By way of background, an OBU is a notional division or business unit of an Australian entity that conducts OBU activities. To be considered as an OBU, an entity must be declared by the Treasurer as an OBU. An OBU receives concessional tax treatment in respect of eligible OB activities, provided additional criteria are met. One kind of eligible OB activity is a trading activity. Amongst other things, trading activity includes trading with an offshore person in shares, securities and units of an offshore entity, as well as options or rights in respect of these shares, securities and units. As a result, trading in the shares, securities or units (or the associated options or rights) of an offshore subsidiary may constitute an eligible OB activity. This has the effect of allowing the conversion of ineligible non-OB activities to eligible OB activities. That is, the offshore subsidiary may undertake ineligible activities and the OBU may claim the same economic benefit as assessable OB income by trading in the shares it owns in the subsidiary.

Potential activities which could be included:

  • Unfunded lending activities (Unfunded lending is where an OBU makes funds available to an offshore person but the funds are not drawn down, or are yet to be drawn down. Income in the form of fees for making the credit available is mobile income and will be treated accordingly as assessable OB income.)
  • Syndicated lending activities (A syndicated lending arrangement involves a number of financial institutions lending to a borrower. Syndicated arrangements are common in large capital raisings. In addition to committing to lend their own capital, an OBU may be involved in arranging contributions from a syndicate of other lenders. The OBU may also be involved in underwriting some of the credit risk. The OBU will earn a fee for these services.)
  • Guarantee activities and connections with Australia
  • Trading in commodities
  • Securities lending and repurchase agreements
  • Non-deliverable forward foreign currency contracts
  • Portfolio investment asset percentages
  • Advice on disposal of investments
  • Leasing activities

The proposed amendments in the draft Bill are:

  • limit the availability of the OBU concession in certain circumstances where it could otherwise be used to convert ineligible activity into eligible activity by trading in a subsidiary;
  • codify the ‘choice principle’ to remove uncertainty for taxpayers;
  • introduce a new method of allocating certain expenses between the operations of a taxpayer’s domestic banking unit and the OBU;
  • modernise the list of eligible activities; and
  • treat internal financial dealings (for example, between an Australian bank and its offshore branch) as if they were on an arm’s length basis.

OBUThe proposals are likely to lead to greater transparency and clarity, and will offer less wriggle room for financial engineering. Though the changes are mainly technical in nature there could be some implications for banks in Australia.

The Reform Imperative

John Fraser, Secretary to the Treasury spoke today to the Committee for Economic Development of Australia (CEDA). The speech, “Australia’s Economic Policy Challenges” outlined some important priorities for economic reform, as well as setting out the background to the reform imperative.

Boosting productivity will require improvements across all markets – input markets such as the labour market, financial markets, and infrastructure markets as well as final goods and services markets. Failure to undertake necessary reforms in related markets will mean that the potential benefits of reform in any single market are not realised. The Government has commissioned a number of policy reviews that will recommend ways to enhance Australia’s economic prosperity. Making the most of these reform opportunities is essential, where three areas stand out as priorities for raising Australia’s productivity performance.

The first is tax reform.

Studies have consistently shown that tax reform offers one of the largest policy opportunities to increase incomes and living standards. And the fact is that the structure of our tax system today looks remarkably like it did back in the 1950s — but our economy looks very different. That may tell us something. Tax reform can promote strong investment and encourage workforce participation. Our company tax rate is high by international standards. In the context of far more mobile capital, high tax rates are dampening investment and productivity, while continuing personal income tax bracket creep would have negative impacts on workforce participation and incentives. An important criterion for a well-functioning tax system is fairness, where there are some contentious and important issues that need to be explored. For example, substantial tax assistance is provided to superannuation savings. We need to consider whether the level and distribution of these concessions remains appropriate. These are the types of issues that will be considered in the upcoming Tax White Paper.

A second priority is continuing to modernise the workplace relations system.

Workplace regulation has been progressively and substantially reformed in recent decades. Many of the fundamental reforms were undertaken in the 1980s and 1990s, in particular the shift from centralised wage fixing to enterprise bargaining. These reforms have delivered substantial benefits. But elements of our workplace relations system may need to change to fit the workplaces of our future. The Productivity Commission’s Inquiry into the Workplace Relations Framework to be delivered later this year will be an important opportunity to create a modern system that will support jobs, promote productivity and lift living standards. A more flexible workplace relations system that supports the economy will help Australia respond to the challenge of lifting productivity growth. The rise of Asia, the ageing of the population and the transition away from resource-led growth will require significant adjustment. It is especially important that workplace laws are not impeding workplace transformation.

A third priority area for structural reform is driving greater competition in goods and services markets.

Previous product market reforms, and those associated with the Hilmer review in the 1990s, pushed competition into non-tradable sectors like electricity, telecommunications and rail freight. These were important changes, contributing to a GDP increase of around 2½ percentage points over the course of that decade. The proposals in Ian Harper’s draft report released in late 2014 provide the opportunity to boost Australia’s productivity performance. The final report will be released in March. Ian Harper proposes that we apply competition law and a new set of competition principles to all purchasing activities of government such as health, education and aged care. Even small improvements here, where government has a large footprint and where Australia’s population will impose greater demands on health and aged care, can deliver big benefits over time. The importance of strengthening competition was also a theme of the Financial System Inquiry. The Inquiry concludes that competition and competitive markets are at the heart of the philosophy of the financial system and the primary means of supporting the system’s efficiency. We must ensure that our banking and financial system more generally are more competitive. The Inquiry also recognised that, as the financial system becomes increasingly sophisticated and innovative, the importance of receiving appropriate financial advice and access to appropriate and competitively priced products has increased.

These are challenging issues and will require the Commonwealth and the State governments to work together.

Groupthink Stems From The Council of Financial Regulators

Behind the scenes, it is the mysterious Council of Financial Regulators which is coordinating activity across the Reserve Bank, APRA, AISC and Treasury. This body, is the conductor of the regulatory orchestra, and although formed initially in 1998, it has only had an independent website since 2013.  It is the coordinating body for Australia’s main financial regulatory agencies. It is a non-statutory body whose role is to contribute to the efficiency and effectiveness of financial regulation and to promote stability of the Australian financial system. The Reserve Bank of Australia (RBA) chairs the Council and members include the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC), and The Treasury. The Council of Financial Regulators (CFR) comprises two representatives – the chief executive and a senior representative – from each of these four member agencies.

The CFR meets in person quarterly or more often if circumstances require it. The meetings are chaired by the RBA Governor, with secretariat support provided by the RBA. In the CFR, members share information, discuss regulatory issues and, if the need arises, coordinate responses to potential threats to financial stability. The CFR also advises Government on the adequacy of Australia’s financial regulatory arrangements. A formal charter was only adopted on 13 January 2014.

The Council of Financial Regulators (CFR) aims to facilitate cooperation and collaboration between the Reserve Bank of Australia, the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission and The Treasury. Its ultimate objectives are to contribute to the efficiency and effectiveness of regulation and to promote stability of the Australian financial system.

The CFR provides a forum for:

  • identifying important issues and trends in the financial system, including those that may impinge upon overall financial stability;
  • ensuring the existence of appropriate coordination arrangements for responding to actual or potential instances of financial instability, and helping to resolve any issues where members’ responsibilities overlap; and
  • harmonising regulatory and reporting requirements, paying close attention to the need to keep regulatory costs to a minimum.

So, given the intended independence of the RBA, from Government, there is an important question to consider. How can this be seen to be true? More likely, we think there is significant potential for groupthink. In addition, no minutes of discussions are made public. We think its time for greater transparency and openness.

“Sunlight is said to be the best of disinfectants; electric light the most efficient policeman” said U.S. Supreme Court Justice Louis Brandeis. We agree.

Treasury Consultation on Resolution Regime for Financial Market Infrastructure (FMI’s)

The Treasure today announced further consultation on a proposed resolution regime for financial markets infrastructure (FMI’s).   Australia was one of sixteen jurisdictions which has no administrative authority responsible for resolution of FMIs. FMIs are defined as multilateral systems used to clear, settle and record financial transactions. They are an essential element enabling financial markets to work smoothly.

  • Clearing is a post-trade and pre-settlement function performed by financial market participants to manage trades and associated exposures. Through the legal process of novation, a central counterparty (CCP) interposes itself between counterparties to transactions executed in the markets it serves, becoming principal to each transaction so as to ensure performance of obligations.
  • Settlement is the point at which the counterparty exposures associated with a transaction are eliminated. In securities markets, settlement is facilitated by securities settlement facilities (SSFs).
  • TRs are facilities that centrally collect and maintain records on over-the-counter (OTC) derivatives transactions and positions for the purpose of making those records available to regulators and, to an appropriate extent, the public.

Internationally, the Financial Stability Board (FSB), the Committee on Payments and Market Infrastructures (CPMI, formerly the Committee on Payment and Settlement Systems (CPSS)) and the International Organization of Securities Commissions (IOSCO) have progressed work on international guidance for FMI recovery and resolution. The FSB adopted the Key Attributes of Effective Resolution Regimes for Financial Institutions (the KAs) in October 2011, and the G20 Leaders endorsed these KAs in November 2011. The FSB subsequently added guidance for applying the KAs to FMIs (the FMI Annex to the KAs) in October 2014. Together, the KAs and the FMI Annex to the KAs identify the powers and limits of a resolution framework for financial institutions, including FMIs. CPMI and IOSCO also published guidance on the development of recovery plans for FMIs in October 2014. The guidance provided in these documents extends to CS facilities and TRs, but not financial markets. The FSB is monitoring jurisdictions’ progress in implementing the KAs, including in respect of FMIs, through a series of peer reviews. The first such review was published in April 2013 and noted that resolution regimes for FMIs were generally less developed than corresponding regimes for banks. Australia was one of sixteen jurisdictions identified in the report as having no administrative authority responsible for resolution of FMIs.

The Australian Government, acting on the advice of the Reserve Bank of Australia (RBA), the Australian Securities and Investments Commission (ASIC), the Australian Prudential Regulation Authority (APRA) (jointly, the Regulators) and the Australian Treasury — seeks stakeholder views on legislative proposals to establish a special resolution regime for clearing and settlement (CS) facilities and trade repositories (TRs), together referred to as financial market infrastructures (FMIs), consistent with international standards. Some of the legislative proposals in this paper relating to directions powers and international regulatory cooperation also extend to operators of domestically incorporated and licensed financial markets. Closing date for submissions is Friday, 27 March 2015.

Although robust risk management significantly reduces the likelihood of an FMI failure, the possibility of such failure is not entirely eliminated. With increasing dependence on centralised infrastructure, motivated in part by regulatory reforms, it is vital that the official sector clarifies how it would address a situation of FMI distress. The particular focus of this consultation paper is on resolution: actions taken by public authorities to either return an FMI to viability or facilitate its orderly wind-down. The associated concept of recovery refers to actions taken by a distressed FMI itself to return to viability. The powers proposed for the resolution authority in relation to FMIs are:

  • Statutory management. The power to appoint an individual, company or the resolution authority itself to temporarily administer a distressed FMI in a manner consistent with the objectives of the resolution regime. The statutory manager would assume the powers of the FMI’s board, including carrying out recovery measures and other actions in accordance with the FMI’s rulebook. The exercise of powers by the statutory manager would be overseen by the resolution authority.
  • Moratorium on payments to general creditors. The power to suspend an FMI’s payment obligations to general creditors. This would exclude payments made in relation to core FMI activities (such as margin payments and settlement of securities transactions).
  • Transfer of operations to a third-party or bridge institution. The power to compulsorily transfer all or part of an FMI’s operations to a willing third-party purchaser, or a temporary bridge institution established by public authorities. A transfer to the latter would be intended as an interim step towards a return to private sector ownership under new governance arrangements.
  • Temporary stay on early termination rights. The power to impose a temporary stay of up to 48 hours on termination rights (with respect to future obligations) that may be triggered solely by an FMI’s entry into resolution. It is also expected that FMIs would ensure that such termination rights were not included in their rules or contracts with critical third-party suppliers.

The powers available to the resolution authority have the potential to significantly impact participants and other stakeholders that have dealings with FMIs. The legislative proposals provide a right to compensation from the Commonwealth should participants or other stakeholders be left worse off in resolution than they would have been had the FMI entered general insolvency. The proposals also include an immunity from liability for the resolution authority, statutory manager and others acting in compliance with the directions of the resolution authority. It is envisaged that in some resolution scenarios, there could be a need to draw on public funds to provide temporary liquidity, to ensure the timely disbursement of operating expenses, or in some extreme cases to meet a small shortfall required to complete an FMI’s closeout processes. In each of these cases the Government would seek to recover any expenditure from participants and shareholders of the FMI.