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March 19th, 2005

I’ve been in Melbourne for the last few days, giving seminars at university departments and talking to people at the Productivity Commission and a roundtable the ACCC. The ACCC event had some very interesting discussion of behavioral economics and its implications. When I get time I’ll do a post on it.

Meanwhile, the Internet has given me nothing but problems. I was trying to deal with comment spam and anti-spam overkill on flaky dialup connections, which was no fun at all. GMail was horribly slow and unresponsive. Then when I got home I got the news that Crooked Timber has been shut down by our hosting service for overloading the database.

All back to normal soon I hope.

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  1. March 19th, 2005 at 06:52 | #1

    The internet is sending you a message.

  2. March 19th, 2005 at 13:10 | #2

    I thought you were professsionally barred from optimism, JQ? That is normal.

  3. March 19th, 2005 at 20:47 | #3

    Just checking to see if the comments is working…sorry.

  4. March 19th, 2005 at 20:47 | #4

    Just checking to see if the comments is working…sorry.

  5. March 20th, 2005 at 01:41 | #5

    So the dismal science is still dismal?. Wasn’t that predicted?

  6. Econowit
    March 20th, 2005 at 22:28 | #6

    Mr Quiggen

    Next time you visit the Productivity Commission please bring this misinformation/disinformation I found in one of your bloggs to their attention :

    “The Productivity Commission, scarcely a hotbed of left-wing activism, recently identified the concessional capital gains tax system introduced by the current government as one of the factors contributing to the unsustainable boom in housing prices, and the corresponding decline in home affordability. �

    You also echoed this inaccurate statement in your AFR article Top tax rate, low priority 24/2/2005:

    “An even more important negative change has been concessional treatment of capital gains, introduced at the height of the dot com mania in 1999â€?.

    The rate at which a capital gain is tax was markedly increased in the Ralph business taxation reforms when they abolished averaging. At the same time they started to tax the inflationary component of the gain. These new reforms ensure that the revenue collected from capital gains tax as a percentage of GDP will increase over time. The net effect to the capital gain taxpayer under the new reforms is that he is worse off.

    The concessional capital gains tax system was tightened by the current government. Please don’t describe it as “an even more important negative change”

  7. John Quiggin
    March 21st, 2005 at 06:16 | #7

    Econowit, do you have any evidence to support the claim that the changes you mention outweigh the 50 per cent offset?

    I agree that this is the case for assets held a long time with modest appreciation, but that only makes matters worse, since it’s a further encouragement of speculation at the expense of productive investment.

  8. Econowit
    March 21st, 2005 at 13:33 | #8

    John,

    Only based on my personal experience, each individual case will be different.

    I realised a capital gain just after they introduced the reforms. There was a transition period when they were phasing in the new CGT. During the transition period people had the option to go with the old way of calculating CGT or adopt the new method. We went with the old method as there was considerable tax savings using averaging and the CPI scales. When you average your income over 5 years, apply a concession for CPI and couple that with a negatively geared income over the period in my case it was better than the present offset.

    There will be cases (short term speculative gains that are the exception rather than the rule) where the new method might be an advantage, but generally the bulk of housing capital gains are obtained over the longer term. In the scheme of things 5 to 10 years of no or negative growth is not uncommon followed by a short period of catch up growth. In my opinion the introduction of a new tax on the inflationary component of the gain is a big negative for people investing in housing- they generally only really achieve modest gains over a longer period. (Between 5 -12% pa compounded capital growth rates)

    Inflation is a big evil that economists seem to ignore or don’t understand. It is the governments equivalent of compound interest and taxpayers are on the wrong side of the equation.

    We have seen what inflation does to marginal income tax scales. It changes it from a progressive tax to a regressive tax. People on low incomes are tax more proportionally and people on higher incomes are taxed less over time. This is because it is impossible to account or adjust for each individuals inflation rate as they are all different -this flaw renders it a regressive tax.

    +at the low income end more low income earners are being taxed who previously were not. This is due to the tax threshold not being adjusted. As inflation dilutes the value of currency, they need more dollars to buy the same good and services. They are no better of in real terms but they are being penalized by the tax system by being introduce to tax (going from 0% to the lowest marginal rate). AN INCREASE IN PERCENTAGE OF TAX FOR PEOPLE ON LOW INCOMES

    +in the middle the effective tax rate of Average Weekly Earnings has increased. Taxation of the average wage has increased from approximately $17 tax per $100 of wage in the early 1980s, to $23 tax per $100 in 2003- 17% TO 23% a 50% increase in the rate ( Approximate figures) AN INCREASE IN PERCENTAGE OF TAX FOR PEOPLE ON MODERATE INCOMES

    +at the top end the abolition or reduction of top marginal rates- A DECREASE IN PERCENTAGE OF TAX FOR PEOPLE ON HIGH INCOMES.

    The biggest economic need is a roof over your head (housing). The alternative to investing in housing is living under a tree.

    The market is teaching the speculators a cruel lesson in the economics of housing. The median values in some areas of Sydney have dropped 18% in the last 12 months. Any speculators holding properties in those areas over the last 12 months with 90% gearing would be looking at negative equity and a sizeable loss if forced to sell. This is all part of the property cycle and it repeats itself with monotonous regularity, burning the speculators and rewarding the long term productive investment in housing that we need. As the down turn is in its early stages we will see this repeated in other regions shortly. (these suburbs are generally regarded as the canary in the mineshaft for the broader housing market).

    Upset the property cycle as Keating tried in the mid 80s and you will see rents sky rocket and the boom and bust in the cycle amplified. I think Keating holds the record for the least amount of time to reverse a major policy when he tried to abolish negative gearing of real estate.

    The tax concessions for housing underpin affordable rental housing in this country and at the same time rewarding patient long term investment with a modest return.

  9. John Quiggin
    March 21st, 2005 at 16:58 | #9

    This was useful, thanks. Next time I write on this, I’ll make more of the point that short-term speculators have been given concessions a the expense of long-term investors.

  10. March 22nd, 2005 at 03:20 | #10

    I wouldn’t say “at the expense of long term investors”, as the system pools all revenues. That is, we can’t specifically sheet it home to long term investors. Rather, we know someone, somewhere, would have been better off – but the alternative package might not have been to long term investors’ advantage, but maybe some other rent seeking group somewhere else in amongst the whole range of tax changes (not just property changes).

  11. Econowit
    March 30th, 2005 at 11:11 | #11

    John,

    It has been a few years since I came across this issue, so I had to go back and refresh my mind. You can find information on it here:

    http://www.ato.gov.au/corporate/content.asp?doc=/content/5413.htm&page=11&pc=001/002/026/004&mnu=4189&mfp=001/001&st=&cy=0

    http://www.ato.gov.au/corporate/content.asp?doc=/content/5413.htm&page=5&pc=001/002/026/004&mnu=4189&mfp=001/001&st=&cy=0

    Governments don’t reduce tax they just rearrange the deck chairs to their advantage as was the case with this reform. There has only been one real tax cut in the last one hundred years and that was in the 1950s when tax as a percentage of GDP fell from 28% to 21%. A golden period in Australias economic history. They say history always repeats itself, so I hope to see a real tax cut in my life time.

    It would in my view it be more accurate to say that the speculators position is unchanged and investors are worse off. A speculator is someone that acquired and disposed of an asset within a 12 month period. They would not be eligible to claim CGT concessions before or after the reforms.

    Yes there was a concessional 50% introduced, but the CGT averaging and CPI concessions removed were not fairly compensated for by the 50% offset. The Productivity Commission position of implying that the changes were a precursor to the housing affordability crisis seem hard to justify, considering the only benefit to the tax payer is the new system is easier to work out- saving compliance costs.

  12. John Quiggin
    March 30th, 2005 at 11:39 | #12

    A couple of points on long-term investors. First, the removal of averaging specifically harms long-term investors since investors who turn over their portfolio regularly don’t benefit from averaging.

    Second, the trade-off between the 50 per cent concession and the removal of averaging depends on the proportion of returns generated by capital gains. If most of your returns come from capital gains, you’re better off. Broadly speaking, this is more likely to be true of short-term speculators in loss-making investments (negatively-geared houses) than of long-term investors in productive activity.

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