Taxes, till death do us part

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Benjamin Franklin wrote anxiously while corresponding to his dear friend Jean-Baptiste Leroy in Paris during the peak of the French revolution about whether he was in fact still alive or had succumbed to the violence.

Franklin wrote (as translated to English): “Are you still living? Or has the mob of Paris mistaken the head of a monopolizer of knowledge, for a monopolizer of corn, and paraded it about the streets upon a pole.

In the same letter, Franklin was feeling the vulnerabilities of life himself, and having just bedded down the US Constitution, he famously remarked: “Our new Constitution is now established, everything seems to promise it will be durable; but, in this world, nothing is certain except death and taxes.”

While not the first to use this term ‘death and taxes’ it is by far the most famous.

The authors of the Re:Think Tax Paper recently released by the Australian Government only wish that tax was in fact as certain as death. The ingenuity of humans whether it be behavioural or technological have managed to highlight the frailties of the current tax system in Australia. It is not longer capable of funding the insatiable needs and wants of government.

While budgets require a tango of expenditure discipline and revenue management,  Australia is struggling like never before to even do the most basic housekeeping on these fronts.

Among the important messages in the Re:think Tax paper, it reminds us that when government tax they change the economy and with that comes the potential to damage economic efficiency if taxes are too high or narrowly based.  Economists call this ‘excess burden’ of taxation, where the benefits of a tax can be overwhelmed by its costs of collection.

Stamp duty on property is identified in the Re:think Tax paper as having a significant excess burden, and I will focus on this because it is a particularly pervasive tax that distorts decision making in business and of individuals. It also has perverse effects like exaggerating the infrastructure deficit.

How does this happen and what are its consequences?

Stamp duty like all taxes has the potential to change economic behaviour. For example, higher income taxes can reduce your incentive to work and stamp duty on conveyances can distort land use, for example by retaining land for relatively unproductive purposes just to avoid stamp duty. The same can be true for individuals when it comes to property ownership and where they choose to live.

In both cases stamp duties for conveyance levied by the states increases significantly transaction costs of buying and selling houses, apartments and commercial land.

Higher transaction costs limit the ability of employers to locate facilities in the most optimal location for access to infrastructure and skilled workers. Equally it directly impacts on people’s willingness to adjust locational preferences for living as their circumstances change over time because of say, a new (another) job, children, health and aging.

With much higher levels of workforce participation, coupled with dramatic reductions in the average tenure of jobs provides some clues as to why traffic congestion is getting worse by the day. Jobs cannot move to people, and people cannot comfortably access jobs is a diabolical mix for our national economic engines. And the solution is, travel more.

Sydney’s major roads such as M5, M1 and M4 all have a daily peak hour exceeding 10 hours per day, and for the more chronically congested in excess of 13 hours. For an equivalent 60km trip in peak hour Sydney,  the average speed is 40 kmh, Melbourne at 44 kmh compared with London at 54 kmh – a city of far greater size and complexity.

Many people may not need to be on the road if they had more choices about where they live, work and play.

A perverse outcome of the tax system I would argue is that it has not only limited work and travel choice, it has exaggerated Australia’s infrastructure deficit. This has caused many commentators to mis-diagnose the cure by supporting even more taxes and debt to invest in better roads and public transport to ease peak hour congestion.

It appears that the new shock absorber to make our cities function smoothly is an over reliance on the transport system which is bearing the burden of an accumulation of tax distortions. Of course, other factors like penalty rates also encourage us to work in the goldilocks eight hour block, exacerbating peak hour traffic as well.

There is an urgent need to better understand the plethora of tax interaction effects with infrastructure and seek to reduce negative consequences.  Taxes and death may share a common inevitability, but our quality of life could be so much better if we managed these negative consequences more thoughtfully.

 

Is Demography Destiny?

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Australia had a bonanza of major reports handed down in the past week commissioned by the Federal government on the challenges and opportunities for the nation to retain its position as one of the most liveable places on earth.

The Intergenerational Report points to the extraordinary expenditure required to support an aging population; while the Re:Think Tax Discussion paper confirmed yet again the tax revenue system is not fit for purpose; and Review of Competition Policy suggests deeper and wider competition could serve the nation better.

Is there any common ground between these reports and what does it mean for Australia’s infrastructure future? Over the coming days, I will comment briefly on each report, starting with the Intergenerational Report now.

Many skilled analysts have fallen into the trap of overplaying the importance of demography by going so far as to argue: demography is destiny for nations.

The thought provoking Equity Guilt studies from Barclays reported in The Economist is a case in point. In 2005 based on population predictions, they expected bond yields would rise 5 percentage points per decade, making them about 9% now. Of course, the prediction has been wildly wrong, not because of a major demographic shift but rather there have been multiple other factors like, GFC, Europe’s debt crisis and quantitative easing.

Interestingly, from an infrastructure perspective the most recent Barclay study has identified another demographic theme, the aging population and its impact through de-accumulation of national savings. The upshot is an expected strong head wind for asset prices in coming decades.

Time will tell whether that is the case,; so far there is only evidence to the contrary when it comes to infrastructure assets.

Recent prices paid for major infrastructure (like Port Botany, Port Newcastle in NSW, Australia) by global pension funds fully exposed to these demographic trends are paying historical highs (+25 times revenue) for the privilege of ownership.

Over playing demography is one risk but the bigger risk is to ignore it altogether.  Demography can still tell an awful lot about the future. It is for this reason that national infrastructure planning should be more closely linked to, and informed by the Intergenerational Report if the authors went one step further in their analysis.

Australians have peculiar land settlement patterns where vast bulk of the population cling to an 80km littoral ribbon running from Brisbane to Melbourne.

The missing link in the Intergenerational Report is for the demographic outlook to be given some basic spatial detail. It would be very helpful for all levels of government to have a basic understanding of the expected settlement patterns and population size that will evolve as we track towards the 22nd Century. But too many politicians deem this type of scenario-based information as too sensitive; they do so at the cost of the nation.

Population projections at postcode level can be extremely valuable, especially over the next 20 years to inform transport and land use planning. It also provides a firmer foundation to reason about what decisions should be made today to ensure future policymakers have good options to deliver the services demanded tomorrow by the community.

Creating and preserving land corridors for transport and utilities is critical. Without it the costs of basic services will be harder to deliver and certainly more expensive. The simple acceptance that land use planning and transport planning is the same thing, would save the nation billions of dollars every year.

Instead there is a lack of willingness to engage the community on the types of questions and issues that go to the heart of championing a sound infrastructure governance process.

Community consultation and trust with our policymakers is very important, and unfortunately trust is trending down. Population and demographic trends provide one of the few evidence bases that can be relied upon to inform better infrastructure decisions.

The Federal Treasury recently stated that the long-term fiscal outlook for Australia is that we can expect to not produce a single ‘budget surplus’ for the next 40 years on current policy settings.

Could it be that too many of our current policy settings are feeding back, contradicting one another and exacerbating the fiscal, economic and social challenges we are trying to fix in the first place; calling for even more taxes and more expenditure.

Can we stop this unvirtuous cycle?

I will revisit this question shortly when I look at the Re:Think Tax Discussion Paper next time.