Home > Economic policy > The Central Flaw in the Henry Review

The Central Flaw in the Henry Review

May 6th, 2010

Because the government ignored most of the Henry Review, I put off reading it until I had a bit of free time. I expected to find myself in agreement with most of it, and in fact, I agreed with a lot. But I found one big problem, as I discuss below (previously posted at Crikey)

As Ross Gittins observed recently, the Henry Review will set the agenda for taxation reform for a long time to come and most of its recommendations will probably be implemented sooner or later. It’s important therefore, to give it some close and critical scrutiny now, before it acquires the status of holy writ.

There’s a lot of good sense in the Henry Review. In particular, its central recommendation, to get rid of the many inefficient taxes and imposts that have accumulated over the years, and replace them with broad, efficient taxes on four bases: personal income (comprehensively defined), business income, private consumption expenditure and economic rents from natural resources and land. On most points of detail, it’s sensible and well thought out, though there will no doubt be room for disagreement.

There is however, a fundamental flaw in the reasoning of the Review, which undermines its whole approach to the appropriate balance between the four tax bases defined above. That flaw is the assumption that the primary goal of economic policy should be to promote economic growth, as measured by GDP (along with other objectives such as equity and sustainability).

The GDP acronym is so familiar that most people don’t even bother to think about the full meaning, Gross Domestic Product. Gross Domestic Product is often used as a measure of economic performance but it has three major drawbacks in this respect

* It’s Gross – that is, depreciation of physical and natural capital is not deducted

* It’s Domestic – that is, it measures output produced in Australia, even though the resulting income may flow overseas

* It’s a Product – the ultimate aim of economic activity is not production in itself but the income it generates, which should be taken to include the economic value of leisure, household work and so on

Most of the time, GDP is used by Treasury departments and others as a handy measure of economic activity, to answer questions like: is the economy growing or contracting, and should policy be expansionary or contractionary. For these purposes, it’s a good tool.

But, if we want to look at policies that promote our economic welfare in the long term, we need to start with another measure, produced by the same National Accounts that give us GDP, but with the errors above fixed. That measure is Net National Income (NNI): the amount of income accruing to Australians, after replacing depreciated capital (the standard national accounting measure of NNI take account of the depreciation of natural capital or the value of leisure, but there are ways to deal with this).

The big problem with the Henry Review’s reliance on GDP comes from its suggestion that we should tax capital lightly because it is internationally mobile. The Review quotes evidence suggesting that a 1 per cent shift in the tax burden from personal income to company income would reduce GDP by around 1 per cent, which looks like a massive cost. The reason is that the company income tax will reduce investment, particularly foreign investment.

But let’s take a stylised (but not totally unrealistic) example and see how it works out. Suppose a foreign company sets up a plant in Australia, bringing in $1 billion of its own capital equipment. Suppose further that the business is sufficiently capital-intensive that the impact on employment can be disregarded, and that any input materials used would otherwise have been exported unprocessed.

Suppose that the business yields the standard return on capital obtained in the international market, say 8 per cent. Then it’s easy to see that annual Gross Domestic Product has increased by 8 per cent of $1 billion, or $80 million. How about Net National Income? The $80 million in capital income all flows overseas, so the impact on NNI is a big round zero.

Which measure should matter to Australian policymakers? The answer, pretty clearly is that the presence or absence of the plant makes no difference to the economic welfare of anyone in Australia, so NNI gives the right answer and GDP the wrong one.

Of course, the stylised example isn’t perfectly accurate. Increased capital investment may lead to higher demand for labour and therefore to higher wages for Australians. But these indirect effects will be an order of magnitude smaller than the effects on GDP, and may be offset partially or completely (for example, if the increased demand is met by increasing immigration).

More subtly, the same kind of argument applies to the Review’s case for preferring taxes on consumption to taxes on investment. If we tax consumption, we are likely to increase savings and therefore have higher income in the future. But that isn’t necessarily a good thing. To assess the impact on economic welfare we need to take into account both the present costs (less consumption now) and the future benefits (more consumption later). Under standard assumptions, these two will approximately cancel out for low and moderate rates of income taxation.

There is a welfare case for taxing consumption, but it’s much weaker than the review suggests. Moreover, the theoretical case, based on the assumption that the tax base is the consumption of Australians, may not hold in reality. On the standard view, we don’t want to tax the consumption of foreign tourists here, but we can’t realistically exempt them and we can’t tax the consumption of Australian tourists overseas. In revenue terms, the two may cancel out, but in incentive terms they both go in the wrong direction.

The government has already followed Henry to the extent of using a large chunk of the resource rent tax revenue to cut company tax rates. We need to think carefully about the justification for further cuts. Certainly, the arguments in the Henry Review don’t constitute such a justification.

Categories: Economic policy Tags:
  1. James
    May 6th, 2010 at 15:01 | #1

    If we’re going to talk about metrics, why not the Human Development Index? Though we currently do very well on this, our economy isn’t going to keep growing (and wouldn’t be worth growing) if we can’t get the education level of the workforce up. Using the HDI as a driver would also force the application of financial policy to the short life expectancy and low quality of life of our Indigenous population, for example by giving them greater rights over the minerals on their lands, or tax breaks for investment in remote indigenous areas.

  2. May 6th, 2010 at 15:18 | #2

    John,

    Your argument about not wishing to offend foreign investors is unconventional. The basis for encouraging such investment is through complementary effects on the demands for other inputs, particularly labour. in the situation you envisage without any labour an investment will be immiserising since its only effect will be to marginally decrease the return to capital. The main positive effect is precisely to enhance the marginal product of other inputs such as labour. Indeed one can show that these effects outweigh effects on capital returns providing gains-from-asset-trade to the economy.

    Your neglect of labour is not an innocent simplification – it eliminates the entire standard basis for seeking greater integration of capital markets. It also ignores tax revenue effects because incomes of workers employed with foreign capital are locally taxable. Indeed the case for supporting the extra tax on resource suppliers in Australia ignores the fact that BHP Billiton, for example, is a major Australian employer. Apart from reducing the attractiveness of Australia as a resource exploration destination (Canada is already crowing about this), deflating the wealth and income of Australian superannuants this super-tax will also substantially reduce Australian government tax receipts associated with mining developments.

  3. jquiggin
    May 6th, 2010 at 15:29 | #3

    James, HDI and similar indexes have a lot of merit as welfare measures (I’ve worked on them), but they aren’t very easy to handle if you want to analyse the effects of, say, a shift from income to consumption taxes.

    Harry, I agree there is an argument to be made about impacts on the marginal product of labour, which need to be set off against the income distributional effects of taxing labour more than capital. My point is precisely that the Henry review didn’t make this argument, but instead relied on the irrelevant point that more investment will increase GDP.

  4. Chris Warren
    May 6th, 2010 at 16:21 | #4

    I do not have time to digest the Henry report, although one thing needs noting.

    Chart 1 |Here| of Henry’s speech “Changing Taxes for Changing Times” is critical. It shows a general, permanent tendency for taxes to increase over time since Federation.

    So here is the real issue, irrespective of all the noise and jabber from various pundits.

    What has caused such a long-run permanent tendency for tax to increase as a percentage of GDP, and how can we turn it off.

    For me, this ratcheting of needed state spending merely points to yet another unsustainable tendency within Keynesian capitalism, and there is little point ignoring it.

    Rudd should be applauded for seeking a super profits tax. Where does this place all the sectarian leftist groups now, I ask?

  5. wilful
    May 6th, 2010 at 16:40 | #5

    What has caused such a long-run permanent tendency for tax to increase as a percentage of GDP, and how can we turn it off.
    pensions, health care, free education.

    What is your a priori case for turning it off? Which government provided services do you not want from government? Please be specific.

  6. James
    May 6th, 2010 at 16:50 | #6

    Chris Warren :What has caused such a long-run permanent tendency for tax to increase as a percentage of GDP, and how can we turn it off.
    For me, this ratcheting of needed state spending merely points to yet another unsustainable tendency within Keynesian capitalism, and there is little point ignoring it.

    At the risk of seeming inflammatory, why would we want to “turn it off”? Government has become increasingly able to do things (Public health, transport, housing, utilities, hospitals, schools, etc), and the population willing to vote for them to do things. That takes money. Currently, there are more things that need doing, (Greenhouse abatement, increased social inequality, saving the Murray-Darling, Closing the Gap, besides all the old ones which need refurbishment after 30 years of neo-liberalism) and Australia’s tax rates are on the low end of OECD rates IIRC.

    Nor do I see why you call Keynesian capitalism “unsustainable” when it gave us the most sustained period of increasing economic prosperity in history. Pre WWII laissez faire and post oil-shock monetarism are much more deserving of the adjective.

    Rudd should be applauded for seeking a super profits tax. Where does this place all the sectarian leftist groups now, I ask?

    Well, the Georgists are extremely happy about it. I don’t understand your praising the super profits tax and condemning the % increase in taxation generally.

  7. Chris Warren
    May 6th, 2010 at 17:10 | #7

    wilful :

    What is your a priori case for turning it off? Which government provided services do you not want from government? Please be specific.

    Why a priori?

    Any ratcheting long-term trend, that cannot continue – has to be addressed.

    Debt as a % of GDP, unemployment as a % of GDP, CAD as % of GDP are similar categories.

    This just points to a general, unexplained instability within Keynesian capitalism. Australia is extremely lucky to have mineral and education exports. Without these billions our economy would be following that of the UK, Italy, Spain, Japan, and of course Greece.

  8. Chris Warren
    May 6th, 2010 at 17:19 | #8

    @James

    At the risk of seeming inflammatory, why would we want to “turn it off”?

    We don’t have a choice. Ratcheting taxation, which is needed to introduce social justice into welfare state capitalism, just leads to a smoke-bombed, riot-torn Athens.

    Keynesian capitalism … gave us the most sustained period of increasing economic prosperity in history.

    No – this was built on; unsustainable increased percapita debt, increased involvement of offshore oppressed working conditions, and unsustainable population increases. Anyone can obtain miraculous living standards if they just issue an IOU for future generations.

  9. Martin
    May 6th, 2010 at 17:29 | #9

    Why not NNI per capita?

    The use of the GDP figure (rather than GDP per capita figure) meant we had to listen to Costello telling everyone to have more babies.

  10. James
    May 6th, 2010 at 17:50 | #10

    Chris Warren :@James

    At the risk of seeming inflammatory, why would we want to “turn it off”?

    We don’t have a choice. Ratcheting taxation, which is needed to introduce social justice into welfare state capitalism, just leads to a smoke-bombed, riot-torn Athens.

    Not according to the Chartalists; according to them, this kind of debt-fetishisation is as imaginary as commodity fetishisation. Governments spending is not constrained by taxation as long as you are sovereign in your fiat currency (which Greece is not). By all accounts, Greece is notorious for tax evasion anyway.

  11. Tom N.
    May 6th, 2010 at 17:51 | #11

    Hi John
    Can you point to the place in the report where the Henry Review says that the goal of economic policy should be to promote growth in GDP. I looked through the Overview and the early chapters and couldn’t find mention of this.
    Thanks, T.

  12. jquiggin
    May 6th, 2010 at 18:00 | #12

    Tom N,

    I’m referring to Part One: Overview Table 2.1, p18 “Table 2.1: Long-run percentage change in GDP per capita from a revenue-neutral shift of 1 per cent in tax revenues — selected OECD countries(a)” in the section headed “The impact of taxes and transfers on economic growth”

    I assume you’re above the quibble that there is no explicit text saying that by “economic growth” the Report is referring to GDP growth (In fact, such an explicit statement, with a defence of this measure, would have been preferable to the implicit assumption that GDP is the only possible measure. At least readers would have been alerted to the issue).

  13. jquiggin
    May 6th, 2010 at 18:02 | #13

    Martin, indeed NNI per capita is the right measure. I assumed this in the post when I mentioned the possibility that increased investment would be offset by immigration, but I will spell it out.

  14. Donald Oats
    May 6th, 2010 at 18:41 | #14

    Does the Henry Review have much to say about negative gearing on houses, or for that matter, about first home owner grants and the like? It seems to me that allowing individuals to apply negative gearing to multiple investment houses is another scenario in which GDP and NNI should give behave quite differently, when compared with the scenarios of either no negative gearing allowed, or negative gearing only on one investment house. Am I right or wrong – anyone?

  15. Tom N.
    May 6th, 2010 at 19:03 | #15

    While the lack of explicit wording does not necessarily invalidate your point, John, I think readers of your blog would be at risk of getting an innacurate impression about the Henry Review from your post. The objectives Henry set for the future tax system include things like efficiency, equity, simplicity and so on. Some of his proposed measures would clearly reduce GDP – pollution taxes, for instance – but are recommended as they would increase economic efficiency or for other reasons. At a broader level, it should be noted that Treasury released a very comprehensive paper on the limitations of GDP as a measure of welfare as long ago as 1964.

  16. jquiggin
    May 6th, 2010 at 19:17 | #16

    Tom N, I didn’t mean to suggest that the Henry Review treated economic growth as the only relevant objective, and I’ve edited to clarify this.

    The problem is that by (mis)using GDP as the measure of growth, they greatly overstated the benefits of cutting capital taxes, in a way that trumps other issues. If shifting 1 per cent of the tax burden away from capital raised national income by more than 1 per cent, you’d be a mug not to do it. Any effects on equity, sustainability and so on could easily be offset from the net gain

    In fact, the improvement in NNI is probably an order of magnitude smaller than this, so there is a real trade-off.

    The fact that Treasury has been aware of the problems with GDP for 50-odd years makes this failure worse, not better.

  17. Chris Warren
    May 6th, 2010 at 19:58 | #17

    Only economic Jesuits would insist on one measure.

    Why not net domestic product?

    I cannot get too excited about income, if it is not linked to product.

    If I destroy capital and then do no more than use its equivalent to replace it, would NNI be zero?

  18. Alice
    May 6th, 2010 at 20:15 | #18

    I see a lot of protection for the supernnuation industry (financial sector) in this review. Its not a protection I am happy with.

  19. Alice
    May 6th, 2010 at 20:30 | #19

    I will say this…everyone complains about “redneck voters” and how slow they are to change. But I do not lose hope. Tonight I had a lovely conversation with my son (18) about how precious his vote (his single vote) is…and how important it is to use it wisely and if there are no acceptable candidates…then to use his vote to destabilise the status quo. He complained to me “Mum…what good does it do? Look at the redneck voters in the US…they never change”.

    At that precise moment…the Greek riots came on to the TV.
    I said to my son….take a good look…there amongst the rioters are your redneck voters who you thought wouldnt change…they do change when things get tough enough and they get there in the long haul. History is littered with uprisings when things get tough enough for the ordinary voter. When they have been betrayed long enough, when their income starts to really hurt, when they have trouble surviving…they change.

    History has shown the disenfranchised and economically threatened have disposed of their oppressors in the process of change for a more equal or fairer state. Tribal voters may be infuriatingly slow to change in what we call a democratic system…but they get there in the end.

    My words to my son… “never lose hope when all about you seem mad or unconcerned or stupid or unquestioning. Every single one of your votes is important even if you feel, at any time, only part of only a small minority for change”.

  20. May 6th, 2010 at 21:29 | #20

    John makes some very good points. I think there will be a lot more said on the theoretical basis of the Henry Review. I am in the middle of writing something on the Review and thought the following part of it may be of interest.

    The Henry Report wants to tax labour income much more heavily than what used to be known as ‘unearned income’. Unearned income is income from investments as opposed to personal exertion. The Henry Report wants it to be discounted by 40 per cent compared with someone who works for a living.

    The ideological justification for lower taxes on unearned income is clear in the way the Henry Report refers to the ‘taxation of income from saving’. The Review shows how by taxing the income on savings, someone who puts away some savings has it greatly reduced after 45 years as a result of taxation of the interest compared with the hypothetical alternative of zero tax and compounding the interest savings.

    Henry can dazzle us with compound arithmetic. Henry portrays the process of investment and the acquisition of wealth in Australia as the result of hardworking individuals salting away their hard-earned, delaying consumption today for consumption on a rainy day later in their lives. Tax on that investment income is frustrating that process.

    But the facts are that household savings over the last decade has averaged less than $10 billion per annum and some of that will be savings on the part of unincorporated business. The total capital stock in Australia is worth around $3,400 billion. The latter figure does not come about as a result of a bunch of workers saving part of their income for use in retirement.

    In fact total savings in Australia averaged $62 billion over the last decade. Evidently the story told by the Review refers to a small part of the issue when it uses the analogy of workers’ savings as the basis for not taxing the income on wealth or taxing it lightly.

    Imagine an economy in which everyone starts out with nothing, there are no pre-existing employers and workers’ savings out of their wages is the only form of creating wealth. Then we get the Henry Report’s vision and its justification for discounting the taxation on unearned income. That story, whereby wealth is merely workers’ savings, cannot really handle the real world of inherited wealth and savings and investment decisions made in board rooms, not around the kitchen table.

    But having said that, our system by and large does lightly tax those vehicles that ordinary working people are likely to invest in, for example, superannuation and housing. Other investment incomes are pretty taxed at roughly ordinary rates when received by individuals. We seem to have stumbled on some sort of rough justice even if there may be scope for change around the edges. We have to be careful not to upset that rough justice by following Henry’s recommendations.

  21. Tom N.
    May 6th, 2010 at 23:06 | #21

    Thanks John. I accept your other points.
    T.

  22. jquiggin
    May 7th, 2010 at 08:40 | #22

    “If I destroy capital and then do no more than use its equivalent to replace it, would NNI be zero?”

    Properly measured, it would be negative, if I’ve understood you correctly.

  23. derrida derider
    May 7th, 2010 at 14:07 | #23

    It never ceases to amaze me how even well trained economists consistently fall into the “more savings/investment must always be a Good Thing” trap. I think you’ve shed light on why – it’s because they have the wrong metric (GDP) of what is a Good Thing.

    Your bit about the welfare effects of a consumption tax is pretty obvious when you think about, but I’ve dealt with quite a few Treasury people who haven’t thought about it.

  24. Tony G
    May 7th, 2010 at 14:32 | #24

    Comrade Rudds ‘politics of envy’ reaction to the Henry Tax review, the super resources tax; imposing an effective 70% supertax on mining profits, isn’t going to leave much fat for the overseas bankers who have to fund a lot of our mining projects.

    LVR’s are going to fall and interest margins are going to increase. If the miners themselves do not shelve new projects, their overseas lenders probably will.

    Good one comrades.

  25. derrida derider
    May 7th, 2010 at 14:34 | #25

    On the long-run rise in taxes as a share of the economy, we’ve gone over that on this blog before. Its because productivity growth in primary industry and manufacturing has been a lot faster for a long time than productivity growth in services. Which means that the relative price – that is, the proportion of human effort needing to be put into them – of services has been increasing for a long time. And governments provide services, not food or widgets.

    It’s called “Baumol’s curse”.

  26. May 9th, 2010 at 16:59 | #26

    On the interaction of capital mobility and corporate taxation, that’s why option 4 of my main submission to the Henry Tax Review revisited the old idea of commuting corporate taxation with direct shareholding:-

    “A class of company should be set up with exemption from corporate taxation but making equivalent issues of shares to the government instead. These shares should be held at arm’s length from consolidated revenue and direct governmental control by selling them to one or another Sovereign Wealth Fund, e.g. the Future Fund or the fund proposed at option (3b.) of my submission on the Retirement Income System, which would specifically apply its revenue to consolidated revenue in lieu of separate taxes and charges (see appendix C). Dividend franking should be continued on the basis of this share revenue, or not, according to other policies about franking. Existing companies should be offered the option to reorganise in this form.”

    There were problems with this in the past, which I analysed and against which I suggested precautions.

  27. May 18th, 2010 at 14:41 | #27

    I come out opposed to the Resource Super Profits Tax (RSPT) for two reasons.

    Firstly, on ecological grounds, as John says in paragraph 4, it’s aimed at increasing GDP. By taxing the most profitable more and removing royalties from the marginal miners, it encourages more ecological damage with less gain (law of diminishing returns). These lower quality ore bodies should be left until a time when the prices of the commodity justifies their mining. It’s encouraging early resource depletion. Some extra GDP at the cost of a lot more holes in the ground.

    On Lateline last week, Emmo (Craig Emerson) crowed about how the PRRT (that replaced a royalty) increased production in Bass Straight. Gee that extra production then (during low oil prices) would be handy now (with oil over US$80 and heading north). Classic case of robbing the future.

    Secondly, by shifting from a constant rate royalty system to a RSPT we are increasing the suspetabilty of the tax base to the cyclical nature of the resource sector. Tax receipts vary between boom and bust times. Currently they vary by royalties changes (changes in production tonnage) plus company taxes movements. In future they will vary by changes in RSPT plus ‘normal profits’ company taxes. The RSPT collects more tax in boom times and less tax than royalties in bust. I saw a table of figures that showed royalties collections versus modelled RSPT collection for the past decade that showed this, but can’t google them at the moment, sorry.

    These are the two main points. There are issues about changes in the balance of federal/state power, due to replacing state royalties with a federal tax. Some COAG friction there me thinks. I’d imagine there will be some heat too when Brisbane & Perth voters realise their royalties funded infrastructure spend is being reallocated to Melbourne and Sydney too.

    Clearly the governments take on resources is too low. The mining companies have bluffed the states into keeping royalties low. Royalties need to be increased, either by the states or by a new federal royalty system. That money should not go into consolidated revenue, but into two funds. An infrustrurtue fund and a fund specificatlly aimed at meeting government future unfunded liabilities. Demographics demends it. Without it, the Intergenerational Reports are so much window dressing.

  28. Alice
    May 18th, 2010 at 20:26 | #28

    @Gnoll110
    Gnoll…quite inexplicably and perplexingly states
    “By taxing the most profitable more and removing royalties from the marginal miners, it encourages more ecological damage with less gain (law of diminishing returns).”

    huh??

    Now how exactly does it do such a thing against all common sense Gnoll? A tax is a tax is a tax and should, ceteris paribus, mean the entity is responsible (not mindlesskly digging holes because it pays little tax) and contributing back to the society from which it profits.

    Yes – they can give something back as the unionists and others sick to death of corporate entities evading tax want. Just tell them to get their hands out of their prockets and pay their taxes and be responsible corporate citizens

    …or do you want us to end up like Greece?

    The only people robbing the future for Australia and other nations are the big miners (and the big oil companies and the big pharmaceuticals and other “bigs” and the utter stupidity of free market global deregulated financial institutions and flows and tax free havens).

    The mining rent resource tax isnt aimed at increasing GDP (how can a tax hike be aimed at increasing GDP) The tax hike on miners aims to get back some of the deficit wasted propping up the economy due to the profligate behaviour of other large corporations and governments, globally.

    As the unions said, and I agree with, its high time the mining executives and companies gave something back to the Australian people. I know it and the ordinary man knows it. The irresponsible lowering of taxes on the highest income earners in industrial nations (individuals and companies) is what has been so tragically fiscally irresponsible in many countries and is now the reason why deficits are what they are.

    Yes – its time they “gave something back to the places where they make their profits” with the exception of Barbados, Bermuda and the Cayman Islands or other hidden wealth tax free storehouses.

  29. Freelander
    May 18th, 2010 at 20:59 | #29

    @Gnoll110

    Both of your ‘arguments’ (using the term loosely) are nonsense.

    There is no improvement in stability if the government forgoes the super profits tax and lets mining companies take home substantial windfall profits that are were never their’s anyway. First, the impact of these windfall profits on mining companies’ share prices is to increase their volatility on the exuberant expectations of all the unearned money falling, and expected to continue falling into their pockets. The high share prices this induces make those prices more susceptible to a dramatic fall, as the last few days indicate. As far as the impact on government revenue and expenditure. Second. Well, with more money the government can put substantial money away to have reserves to draw on in event of a downturn. Continuing the pittance obtained with the royalty system does not provide this option.

    As far as save the environment goes… There is no reason to believe that just because a mining opportunity is marginal, that that project will necessarily be more environmentally damaging than a very profitable one. Indeed there is reason to believe the opposite.

    If a project is only marginally profitable but has some potential environmental impediments it is not worth the risk of going ahead in case those impediments stop it, because there is no pot of gold to offset those risks.

    With a super profit tax the pot of unearned gold is diminished in all cases, so for all potential projects that might have some environmental impediment there is less motivation to go ahead, and less motivation to engage in lobbying, bribery and corruption to make the environmentally damaging project happen.

    Thus, neither of your arguments is convincing.

  30. May 18th, 2010 at 21:18 | #30

    @Gnoll110

    While I support the RSPT proposal Gnoll, I do agree your most telling point id the encouragement it gives to marginal mining operations, both on resource and environmental grounds. It’s a shame that RSPT is quite unlikely to stifle the harvest of resources by extractive industry and the associated Dutch Disease style problems.

    I’d probably tweak the proposal so that the RSPT was progressive over the 6% bond rate and maxed out at about 50% around 2400 points over the bond rate. I wouldn’t be putting aside money against unfunded liabilities. Rather, I’d probably be hypothecating against super — so that a fixed proportion (perhaps 5%) of the revenues raised above the various offsets proposed went into the super funds of the people in the bottom six declines of the population. A condition of getting this would be an acceptance that the funds so added and the accrued interest could only be taken as an annuity and would be assessible against future pension benefit.

    Otherwise the funds would be put into a sovereign wealth fund and provide a funding base for major infrastructure projects — environmental, water, health, transport, education, housing, communication etc.

  31. Freelander
    May 18th, 2010 at 21:25 | #31

    @Fran Barlow

    Actually, that is a very good idea for labor to sell the tax. Better still, hypothecate some of the additional tax revenue into the super of likely labor voters in all the marginal seats. That could do the trick!

  32. Freelander
    May 18th, 2010 at 21:26 | #32

    Where’s my whiteboard?

  33. Alice
    May 18th, 2010 at 21:36 | #33

    @Fran Barlow
    As I see it – sovereign wealth funds are under stress even now given the parlous state of the global financial economy…so why give them more to play with Fran?
    Give the money to the bottom six deciles to spend as they see fit. Let individual choice reign free and stop nannying people to save for their retirements (so that govts and the finance sectors get fat and healthy from their cut). What the latter misses out on – they can go in search of another resource tax from yet another healthy yax avoiding industry. Plenty of those. High hanging fruit thats been left to rot.

  34. May 18th, 2010 at 21:59 | #34

    @Freelander

    Well marginal seats would be a bit naughty and of doubtful net value. You’d have to make aguess on booth by booth.

    But the broader idea of setting up the rich mining bosses against the least advantaged population’s future interests and inviting the crowd to decide what was a fair thing appeals. Those bottom six deciles are probably 70% of the voting public.

    Preservation as an annuity ensures that future liability is reduced, so in a sense, it really is money in the bank.

  35. Freelander
    May 18th, 2010 at 22:48 | #35

    Yes, and the joke is, of course, that the poor tend to not live as long as the rich so, because super funds do not take this into account when they provide annuities, the poor tend to cross subsidize the riches super. Serves them right I suppose for ‘choosing’ to be poor.

  36. May 18th, 2010 at 22:56 | #36

    @Alice & Freelander
    Sorry people, I took it as read that people understood that the quality (and thus the profitability) of an ore body is on a continuum. Just like agricultural potential of soils vary from the rich reds & blacks of rotted basalt to the light sandy soils of weathered sandstone. At any set of market condition, some bodies will be profitable, some marginal and some unprofitable. Marginal, by definition means small gains for the effort required. Change conditions, like taxation treatment, and you do is this case change where marginal lies on the continuum. The move from a royalty based system to a RSPT will make now unviable projects become viable.

    All mining is a land killer. I work on the principle that the less mining (by area) the better. In that the RSPT favour marginal mining (vs flat royalty system), I’m totally against it. I’ve lived less than 15 minutes from an expanding open cut coal mine and watched it eat the land and seen a town die and be stripped back to the soil (they dig up foundation slabs and septic tanks, the lot). Mine rehabilitation is a marketing have, aimed at keeping city people “fat, dumb and happy”. I really don’t think there is much difference between the damage done by a profitable mine and marginal mine. So the fewer mines the better.

    Interesting, there is a link between mine viability and land suitability for farming. I think mines on good (well watered) farmland tends to be more profitable because of the ready access to water reduces the cost of on-site processing & that closely settled farmland (vs remote desert) offers more local labour (and thus lower labour costs). So mining naturally gravitates to the land where it can do the most damage.

    I’m all for raising the governments take for mining, I thinks raising royalties is a better way. Get a bigger percentage of the total revenue, over taking a bigger percentage of after expense profits. Get in first before they start expensing stuff, before the creative Accountants get started. Raise royalties enough and you’ll get the same dollars as the RSPT.

    In the last paragraph, I propose that the revenue from a higher level of royalties should go into a “fund specifically aimed at meeting government future unfunded liabilities”. This I proposed exactly to covers the main source of problems that will lead Australia into a Greek situation. I also believe without action we will get to the Greek destination. I also doubt our current pollies, on either side, have the wear-with-all to take the measures needed.

    What we really have is two questions.

    1. Do we use a royalty based system or a RSPT system? I’m clearly favour continuing with the royalties system.
    2. How much extra revenue do we need to raise? Apart from lots, I’ll leave that questions to the Actuaries.

    I hope that clears up that I’m being soft on miners. I genuinely believe continuing a royalty system (preferably at a higher rate) will lead to a smaller mining footprint with a better return for the amount of permanent damage done.

  37. May 18th, 2010 at 22:56 | #37

    @Alice & Freelander
    Sorry people, I took it as read that people understood that the quality (and thus the profitability) of an ore body is on a continuum. Just like agricultural potential of soils vary from the rich reds & blacks of rotted basalt to the light sandy soils of weathered sandstone. At any set of market condition, some bodies will be profitable, some marginal and some unprofitable. Marginal, by definition means small gains for the effort required. Change conditions, like taxation treatment, and you do is this case change where marginal lies on the continuum. The move from a royalty based system to a RSPT will make now unviable projects become viable.

    All mining is a land killer. I work on the principle that the less mining (by area) the better. In that the RSPT favour marginal mining (vs flat royalty system), I’m totally against it. I’ve lived less than 15 minutes from an expanding open cut coal mine and watched it eat the land and seen a town die and be stripped back to the soil (they dig up foundation slabs and septic tanks, the lot). Mine rehabilitation is a marketing have, aimed at keeping city people “fat, dumb and happy”. I really don’t think there is much difference between the damage done by a profitable mine and marginal mine. So the fewer mines the better.

    Interesting, there is a link between mine viability and land suitability for farming. I think mines on good (well watered) farmland tends to be more profitable because of the ready access to water reduces the cost of on-site processing & that closely settled farmland (vs remote desert) offers more local labour (and thus lower labour costs). So mining naturally gravitates to the land where it can do the most damage.

    I’m all for raising the governments take for mining, I thinks raising royalties is a better way. Get a bigger percentage of the total revenue, over taking a bigger percentage of after expense profits. Get in first before they start expensing stuff, before the creative Accountants get started. Raise royalties enough and you’ll get the same dollars as the RSPT.

    In the last paragraph, I propose that the revenue from a higher level of royalties should go into a “fund specifically aimed at meeting government future unfunded liabilities”. This I proposed exactly to covers the main source of problems that will lead Australia into a Greek situation. I also believe without action we will get to the Greek destination. I also doubt our current pollies, on either side, have the wear-with-all to take the measures needed.

    What we really have is two questions.

    1. Do we use a royalty based system or a RSPT system? I’m clearly favour continuing with the royalties system.
    2. How much extra revenue do we need to raise? Apart from lots, I’ll leave that questions to the Actuaries.

    I hope that clears up that not I’m being soft on miners. I genuinely believe continuing a royalty system (preferably at a higher rate) will lead to a smaller mining footprint with a better return for the amount of permanent damage done.

  38. May 18th, 2010 at 23:09 | #38

    @Freelander

    It is true that the poor tend not to live as long as the rich, but in terms of super, it makes no difference. Your annuity is paid out of what you or others have deposited and the interest on it. Balances go to your estate and that can be passed on.

    Of course we should work hard to address the factors leading to lower life expectancy amongst the disadvantaged — that was the other part of what I was proposing.

  39. May 18th, 2010 at 23:24 | #39

    Ignore 36 (can we delete please), read 37.

    By the way people, a huge source of unfunded government liability is defined benefit public service super. This is why I think we need the second fund, specifically for unfunded liabilities.

    Yer, might as well give the money to the bottom 6 deciles, government doesn’t seem capable of taking any measure to prepare for global warming, peak oil or any other form of habitat destruction and resource depletion. Unfortunately lots of this planning only works as part of a far larger scale undertaking. We’re all doomed I say!

  40. Jarrah
    May 18th, 2010 at 23:54 | #40

    @Alice
    “Give the money to the bottom six deciles to spend as they see fit. Let individual choice reign free and stop nannying people to save for their retirements”

    Very libertarian of you!

  41. Freelander
    May 19th, 2010 at 01:55 | #41

    @Gnoll110

    You are not teaching anyone here. Nothing in my comments indicate that I don’t understand that there are projects that become viable after a switch from royalties to a super profit tax.

    @Fran Barlow

    This ‘equivalence’ is certainly not true in general and really depends on the scheme.

  42. May 19th, 2010 at 05:46 | #42

    @Jarrah

    It may be more right wing libertarian Jarrah, but it would not be good policy. It would after all, provoke an increase in consumption at the expense of saving and the foreclosure of future pension liability, out of a windfall resource.

  43. Alice
    May 19th, 2010 at 06:59 | #43

    @Jarrah
    Yep Jarrah – when it comes to the monumental charade of “super” I am very libertarian!

    Super IMHO helped blow up the bubble and is still feeding the overblown financial sector. I dont think Fran is right that it would provoke an increase in Consumption…and even if it did now it would be good for the budget deficits and job creation. Most are responsible and can save for their own retirements and dont need their hands held or a whip to do so. Mandatory super has allowed both govts and the financial sector a cut of our savings. If I want to give a cut of my savings to someone Id like to decide who I give it to Jarrah.

  44. May 19th, 2010 at 08:45 | #44

    @Freelander
    “Projects that become viable after a switch from royalties to a super profit tax” is a central premise of this Henry Review measure. Refering back to John’s premise that that Henry Review is flawed by “the assumption that the primary goal of economic policy should be to promote economic growth, as measured by GDP”. GDP growth is expected out of the RSPT, indeed, I heard a sound bite of Ken Henry on the radio in the last hour saying that long term RSPT will increase mining.

    I’m not sure that this RSPT will produce more mining. Cutting the new tax in at the long term bond rate may not produce a big enough window of lower taxation to tempt new players into the game. I’ve been wrong before, time will tell.

    Remember the miners only opposed this when they found out the rates and cut in point a few weeks ago. When the RSPT was originally aired, they wanted to talk, figuring they could get the large lower tax window at margin at the cost of a small increase of overall taxation. They were willing to take a slightly smaller cut of a considerably bigger pie.

    Back to wear I started. I support continuing royalties exactly because it doesn’t create a lower tax window at the margin. Personally I want fossil fuel miming wound back, in this regard the RSPT is worse than the status quo.

  45. wilful
    May 19th, 2010 at 09:57 | #45

    Gnoll, that’s an interesting point that you have raised, that I thought of independently, but haven’t seen anywhere in print. The RSPT is perhaps an inefficient tax, because it “goes after” the most profitable activities. Wont this encourage more less profitable mines, more marginal activity, while slowing the pace of development of the best mines?

    Though it’s all a matter of net benefit across the sector, i still expect the RSPT is very justifiable.

  46. Fran Barlow
    May 19th, 2010 at 10:10 | #46

    @wilful

    I’m not sure if this isn’t one of those things that is more apparent than real. No super profitable mine (or one believed to be potentially super profitable) is going to be abandoned because if the mine does turn out to be super profitable it won’t return quite as much super profit to equity holders. Given that the structure of the tax is shielding the investor from downside risk, the 6% bond rate mark seems very fair.

    Nor does the royalty system work all that well if there is doubt because the equity holder takes a bigger risk of sub-par returns — one that might be avoided by investing elsewhere. That risk leverages low royalties to the state governments so that in effect, the more apparently marginal mines still get worked and if they turn out to be better, the cream goes to the equity holder. In order to maximise royalty income, the states become very sensitive to issues affecting mining and tend to privilege these over other competing rural interests — like farming for example, and as we have seen, the community in general in realtion to climate change.

    As I’ve said many times, the states ought to be abolished and all of the revenue collected from mining ought to go to the Feds to be doled out to regional governments to run co-ordinated progams affecting their locality while overall policy is configured centrally. Then we could get away from parochial and extractive-industry driven politics.

  47. May 19th, 2010 at 10:28 | #47

    @wilful
    Good question. Not sure, don’t know.

    I think it depends on how well Australia has been explored for any given mineral. If Australia is well explore than most high grade body should already be in production (remembering there is no grandfather clause, unlike the PRRT). If not well explore, then you could expect some slow down. The further out you look the murkier it gets.

    On point I try to remember is that humans generally over estimate short effects of a change and under estimate the long term effects.

    One point to remember the ‘across the sector’ thinking can misleading, when the plays in a sector are not a homogeneous group. Established player like BHP-Billiton & Rio Tinto will behave differently to a start-up trying to develop its first mine.

    From the tax & growth angle the RSPT may well be justified. But it comes back to John’s original idea of the hunt for GDP growth being flawed. Looks to me that Australia has the coal/gas/iron equivalent to the oil curse. Resource extraction dominates, forcing everyone else to be economic rent seekers. This whole thing stink of it!

  48. May 19th, 2010 at 10:59 | #48

    @Fran Barlow
    I like the fact that royalties produces “doubt because the equity holder takes a bigger risk of sub-par returns”. The point is that the government always gets it’s cut up front, whether the equity holder win, lose of draw. After all the resources has been consumed, whether the equity holders win, lose or draw!

    You’re very right about the state’s level of royalties, the miners have the states bluffed into keeping royalties low. All that money makes the states favour mining interests over other interests.

    Wouldn’t go as far are abolishing the states. The good old paradox of government, leadership vs democracy.

  49. Fran Barlow
    May 19th, 2010 at 11:30 | #49

    @Gnoll110

    You’re very right about the state’s level of royalties, the miners have the states bluffed into keeping royalties low.

    That’s right but they are overstating the risk in many cases and so getting a fere ride that looks fairer than it is to the community as a whole, and because the state come as supplicants, the public is always at the wrong end of the stakeholder queue. So that is no good. The miners need to play against the Feds not the states which they can pick off.

    Wouldn’t go as far are abolishing the states. The good old paradox of government, leadership vs democracy

    The structure in Australia is too top heavy to begin with. Get rid of the councils and the states and have regional government (which can devolve power to precincts where needed).

    Regional government is likely to put up a better show against disentegrative and corrosive political finagling than local government and the Feds won’t be as amenable as the states to local pressure on macro policy either. On the other hand, if there is a whole of nation issue, the states can’t stand in the way.

  50. May 19th, 2010 at 11:45 | #50

    @Fran Barlow
    Guess I’m still too much of a democrat and am prepared to put up with the anarchy of over government. Fear a emergent dictatorial nature of single layer of government too much to support abolition of the states. *refers back to the paradox of government*

    Philosophical difference I guess.

    Anarchy is transitory, dictatorship is for keeps.

  51. wilful
    May 19th, 2010 at 12:12 | #51

    Yeah, the argument in favour of removal of states is basically that we need less democracy, less accountability.

    I know that Spring Street is far more accountable for what happens in Melbourne than Canberra ever would be.

  52. Fran Barlow
    May 19th, 2010 at 12:46 | #52

    @wilful

    But that’s just it Wilful … Melbourne and Geelong might be its own regional government. It would be fully accountable for what happened in melbourne and geelong that wasn’t a national issue.

    On the other hand, neither Melbourne nor Adelaide nor Sydney would be in charge of the water flow in the Murray Darling, or the funding and staffing of public hospitals, or national transport or resource or communication policy on behalf of the sectional interests involved.

  53. Fran Barlow
    May 19th, 2010 at 12:53 | #53

    @Gnoll110

    Well I’m much less fearful of dictatorship and if I were, I wouldn’t attach any significance to the existence of state governments.

    What we get with over governance is not “anarchy” but policy gridlock.

    I favour optimal policy over sub-optimal policy but if you ask me to choose beween sub-optimal policy and policy paralysis followed by a dog’s breakfast which meets few outcomes at great cost, I will choose sub-optimal policy. And haven’t we seen a bit of that recently?

    At least with sub-optimal policy we can see where it is failing and rapidly revise it. With what we have now we don’t get to find out how good or bad something is — we just get talk incessantly until most of us are so sick of the topic that a rotten compromise emerges and then we start the whole game again in some other area.

  54. wilful
    May 19th, 2010 at 13:13 | #54

    I know I’m the last of the federalists, but…

    …actually, debating the abolition of the states is pretty tedious. It’s not going to happen in a hundred years. If/when a credible politician suggests it, then we can maybe bother talking about it properly.

  55. Fran Barlow
    May 19th, 2010 at 14:06 | #55

    @wilful

    It’s a bit like TOUT* isn’t it?

    Still, if we don’t at least mention it then it really never will get onto the agenda, and in my opinion, it’s the single most significant legal reform this country should undertake — far more important than republics and bills of rights. If we got that done, we’d be in a far better position to move forward.

    *that other unmentionable topic/technology

  56. wilful
    May 19th, 2010 at 16:29 | #56

    Good similes Fran. So lets see how the far more modest Republic and Bill of Rights issues have gone… erm, nowhere. Despite major support.

    Australia isn’t as broken as the US, not by a long shot, but fundamental change in anything is just not currently possible in this media climate. The Australian, for gawd only knows what reason, seems to set the national agenda, the ABC follows, Fairfax is declining, and the blogosphere is for wankers (including me).

    We do have some decent intellectuals in the country, including in Canberra, but everyone’s too gutless to listen to them. Even Ken Henry! Ross Garnaut! Totally orthodox mainstream types.

  57. May 19th, 2010 at 18:38 | #57

    @Fran Barlow
    In this case I take the same approach as the Greens did with the ETS. The policy is so sub optimal that it’s better to maintain the status quo and wait from the next train.

    Personally I’ld be telling the states for lift their royalties to a given figure (for each commodity) and that if they don’t, the feds will pocket the difference. Just like the feds have just done with 30% of the GST and health spending. Good old federalist/COAG argy bargy.

    Agreed, having states does not deny dictatorship. History shows there are many ways to dictatorship. Each needs its checks and balances. As one of many checks and balances I’ll keep the states (a multi level system) thank you.

    I think the recent federal fiascos show that we’re currently not up to having one layer of government even if you could design a safe system.

  58. Alice
    May 19th, 2010 at 19:44 | #58

    @Gnoll110
    What about NSW State Labor? Would you trust them?

  59. Alice
    May 19th, 2010 at 20:06 | #59

    @wilful
    If the US breaks further Wilful…dont make the mistake of thinking it wont break us as well….and the US is pretty broken.

  60. May 20th, 2010 at 08:57 | #60

    @Alice
    No Alice, don’t trust them either. The point of having a multi layers is that it lessens the chance of them all being ‘of the rails’ at the same time.

    System design rules, avoid single points of failure. Another systems dynamics rule is that a system only needs to work well enough that it doesn’t fail as a whole/altogether. Complex system generally operate with some sub-systems in failure. So what exacly is the appendix for anyway? ;)

  61. May 20th, 2010 at 11:44 | #61

    I note on the radio today, that at least one local government body, the Western Down Regional Council want direct access to royalties. Specifically to fund infrastructure. This council at one point last year had 8 hour of water usage in it’s distribution systems/reservoirs for it’s main centre, Dalby. There were two causes for this problem, additional damage due to high mining related growth and a grain ethanol plant using more water than planned/allocated. This council covers part of the Surat Basin.

    http://www.abc.net.au/news/stories/2010/05/20/2904416.htm

Comments are closed.