Balancing the books

I’ve been at the Australian Conference of Economists for the last few days. Today we had presentations from the Queensland Treasurer, Curtis Pitt, who is about to bring down his first budget, and from Commonwealth Treasury Secretary, John Fraser.

Curtis Pitt’s big announcement was a rearrangement of debt and equity in Government Owned Corporations, increasing their borrowing and transferring the resulting equity to the general government balance sheet. The result is a $4 billion reduction in general government debt, part of a program to bring the debt/revenue ratio down to around 70 per cent.

A transfer like this doesn’t make any difference to the state’s net financial position. Bu it makes the point that publicly owned assets are assets, not liabilities, and the fact that we own them makes the state’s position stronger. As long as the higher gearing ratio is commercially sensible and the debt can be serviced out of GOC earnings, there’s no reason not to use this to improve measures of general government debt.

Privatisation also makes no difference to the net position, assuming assets are sold at their value in continued public ownership, and the proceeds are used to pay down debt. However, the StrongChoices plan put by the LNP at the last election, would have dissipated around half of the sale proceeds on pork-barrel projects (to be delivered only if the LNP won the seat in question). So, compared to the alternative, Labor’s management is fiscally responsible.

The only measure that is unaffected by balance sheet reshuffles (at least if it is correctly measured) is net worth, and the only way to increase net worth is for income (revenue and asset earnings) to exceed expenditure.

John Fraser’s performance was as expected, which is to say, deeply disappointing. As a colleague sitting at our table remarked, he came across as a politician not a Treasury secretary. Fraser repeated the Henry Review’s criticism of stamp duties and the case for not taxing mobile capital. But when I asked if that meant he supported land taxes, he squibbed the question, waffling on about what a great group of officials he was working with in the states.

43 thoughts on “Balancing the books

  1. Thank you for the information on the Queensland Treasury’s ‘balance sheet restructuring’. It seems to me to be a smart move, given borrowing costs are quite low at present.

    What is ‘mobile capital’?

    Does it mean financial securities? If so, why pretend contracts with numbers on them move around all by themselves?

    Ha, JF either doesn’t like you or he has an inefficient use of the English language. I assume it is the latter.

  2. As a colleague sitting at our table remarked, he came across as a politician not a Treasury secretary

    Having observed the fate of his predecessor, he has probably decided that frankly might lose him his job. He is probably right.

  3. John failed to note that Pitt in his talk had a gentle dig at him (by name) as a critic of both sides of politics whenever they tried any financial innovation – maybe he was hoping to forestall more criticism from this quarter 🙂

    Fraser’s talk was fairly unimpressive, certainly compared with the beauties we used to get from Ken Henry. I don’t think it was so much political – certainly not partisan – as full of platitudes. This guy is not going to stick his head above the parapet much.

    For me one takeaway from the conference was the near-consensus in the profession that we should be borrowing a lot more to spend on infrastructure while funds are so incredibly cheap – in other words, borrow so long as we spend the funds on things that generate a return. This included even the financial market economists (who are usually big on fiscal consolidation whatever the circumstances). IOW we should have MORE debt at the moment (though that said many argue we’ll have to wind it back later due to demography). So much for Hockey’s “debt emergency”. Another takeaway is that behavioural economics is incredibly fashionable at the moment – and people are keen to apply it to policy in quite naive ways.

  4. @Kel Y
    Derrida explained why in his post. Because of our current economic standing we are able to borrow incredibly cheaply. Therefore, even if we invest in only modestly profitable enterprises we will make money overall.

  5. @DD That wasn’t quite my interpretation of Pitt’s remark about me – I thought it was more specifically about privatisation.

    As regards Fraser, I meant that he spouted the government’s line and ducked anything that would go against that.

  6. @John Quiggin
    Have you read the Age article about Fraser’s speech? (Fraser) ‘has called for a fresh wave of industrial relations reform, for spending cuts deep enough to slash income tax and for land tax as a replacement for stamp duty’

    Are spending cuts what we need?

  7. @Kel Y
    Printing money, Nathan, IS borrowing. A banknote is a Treasury bond redeemable at call, paying 0% nominal interest. If the government issues more money it owes more.

    The relative merits of orthodox bond finance and of Quantitative Expansion (which is what printing money is) in the current circumstances are beyond the scope of this comment (plus I reckon neither you or I know enough to merit having a strong view), but the effects on the government’s balance sheet (though not income flows) are similar.

  8. I too have been disappointed by Fraser particularly compared to Ken Henry. I get the feeling that Henry was just smarter. But I do support reduced taxes on capital that, evidence shows, fall very strongly on labour. Indeed, apart from capturing the non-imputed company income that accrues to foreign investors I cannot see much of a case for taxing company profits at all.

    That view is not a right wing line. I think it is now the consensus position in the tax literature. Certainly Ken Henry favoured lower company taxes.

  9. @derrida derider
    So it’s contained on a spreadsheet somewhere? Plus what is the effect of owing more Australian dollars when you are its only source? I can only think of an inflationary downside in an overheating economy and we are far away from that.

  10. @Kel Y

    You are quite correct. There is no intrinsic requirement for a government with a fiat currency to borrow in any way to “print” money. These days if money is “printed” it is actually just electronically credited by the government to certain kinds of bank and/or private accounts. Certain kinds of accounting recording might well accompany this process.

    Lay people tend to badly REIFY modern fiat money, treating something abstract and nominal as if it were concrete or real. Unlike real material things, fiat money can be created out of nothing and destroyed into nothing. Debt backed money can also be created out of nothing and put into circulation by commercial banks albeit they record a corresponding debt on their books. While that debt sits there on the books (say it is $500,000 of housing debt) doing in essence nothing and waiting to be repaid, the $500,000 created electronically goes into the borrower’s account and he/she then pays (let us assume) $500,000 for (let us assume) a house with no mortgage on it. The people who take this new $500,000 can put it into circulation in the economy by any kind of spending. The time difference is what matters here. The debt waits for years to be slowly extinguished by fortnightly payments taking money out of the economy in small increments. The $500,000 usually goes into circulation or at least somewhere into the high powered money base straight away. Hey presto! Even commercial banks create money out of nothing.

    Footnote: Some economists argue that MMT essentially presents no new insights and that its understanding of money is implicit in Keynesian economics:

    “… post-Keynesian economist, Thomas Palley argues that MMT is largely a restatement of elementary Keynesian economics, but prone to “over-simplistic analysis” and understating the risks of its policy recommendations.[25] In a later article, Palley criticizes MMT for essentially assuming away the problem of fiscal – monetary conflict and rebukes the MMT claim that old Keynesian analysis doesn’t fully capture the accounting identities and financial restrains on government that can issue its own money; Palley shows that these insights are well captured by standard Keynesian stock-flow consistent IS-LM models, and have been well understood by Keynesian economists for decades. He argues that the policies proposed by MMT proponents would cause serious financial instability in an open economy with flexible exchange rates, while using fixed exchange rates would restore hard financial constraints on the government and “undermines MMT’s main claim about sovereign money freeing governments from standard market disciplines and financial constraints”. He also accuses MMT of lacking of a plausible theory of inflation, particularly in the context of full employment using their proposed ‘Employer of Last Resort’ system, a lack of appreciation for the financial instability that could be caused by permanently zero interest rates, and overstating the importance of government created money. Finally, Palley concludes that MMT provides no new insights about monetary theory, while making unsubstantiated claims about macroeconomic policy, he argues that MMT has only received attention recently due to it being a “policy polemic for depressed times”.[26]” – Wikipedia.

    I just quote that to indicate I am not necessarily plugging MMT here.

  11. Suppose company taxes would be abolished. And suppose this happens everywhere. Then all countries will be ‘tax havens’ and the transfer pricing problem is solved.

    It doesn’t cost very much for people, who are currently selling their labour as employes, to change there status to companies. There goes income tax. Joe Hockey faces a nightmare but he will be only one of hundreds of treasurers of the corporate income tax free global economy.

    Ultimately, ‘all tax falls on labour’. True, if ‘labour'(L) means people (P). But, we can’t just simply say let L = P because, if we look at P = 1, ….., n then we find some members of P also get income from non-labour services (rental income, dividends, interest, ….), while others don’t.

    Without talking at the same time about a total reworking of the personal income tax structure such that the wealth distribution becomes less concentrated and government revenue is secured for the provision of social services as well as law and order, I find it difficult to imagine what the concensus is supposed to be about other than worse than now.

    No, the printing of money as per MMT is not credible.

  12. And, if we look at P = 1, …., n in ‘the global economy’ then multinational corporations can still transfer real resouces among subsets of P (in a partially segmented economy) even if tax incentives are removed.

    Why? Because a global producer can use profits made in one local economy to buy inputs from this economy, do the same in another local economy and sell the output in a third local economy.

  13. @Ernestine Gross

    Good points. It makes me wonder what are the best taxes to run in an economy? My first thoughts on the matter are that good taxes will be (and some of this is going to sound like motherhood and apple pie but bear with me):

    (a) As simple as possible;
    (b) As unavoidable as possible; and
    (c) Imposts on “bads” not on “goods” so far as possible.

    Leaving aside the black economy, it now seems that taxes on finance flows and consumption flows would be the easiest to levy in this computerised age. Taxes on income and capital seem more difficult for a number of reasons. I won’t bother enumerating these reasons now.

    Taxes on legal, end-consumer consumption in the legal economy seem unavoidable. If you buy legal goods or services from a legal trader or business, you ipso facto pay the consumption tax.

    Consumption taxes need not be regressive. It would possible to tax via a schedule for example;

    (a) fresh food 5%
    (b) processed foods 10%
    (c) general groceries 10%
    (d) undefined/uncategorised goods and services 10%
    (e) restaurant foods not covered in (f) 15%
    (f) junk foods and fast foods (specifically defined categories of items) 25%
    (g) essential white goods and electronic goods (defined) 10%
    (h) non-essential white goods and electronic goods (not defined in g and i) 15%
    (i) luxury goods (defined) 35%
    (j) alcohol, tobacco and other defined “bads” 50% (or whatever is required

    and so on.

    In addition, negative externality taxes can be added for goods generating defined negative externalities (thus Pigovian taxes).

    Finally, a Tobin tax.

    Set correctly, could these taxes alone supplant all other taxes? Should they or are there other types of taxes we should levy?

    Also, perhaps taxes should do none of the work of welfare transfers and explicit welfare and certain free services (e.g. mass transit) should do all the work?

    The above assumes no basic changes to capitalist ownership which I would like to see of course but keep out of this tax hypothetical.

  14. Ernestine, “It doesn’t cost very much for people, who are currently selling their labour as employes, to change there status to companies. There goes income tax.”

    No it doesn’t, the income the companies they form pay them is taxed as income. That’s what happens now with unincorporated enterprises.

    Companies don’t need to exist as taxable entities since everything they earn is paid as factor returns (taxable) or as dividend income (taxable). Indeed that is what the imputation system recognises. As I say the only advantage is that it drags in tax revenue from foreigners who don’t benefit from imputation credits. This creates its own distortions however by raising the return on capital to resident shareholders who face incentives to inadequately invest in foreign capital. Of course it also reduces the net return to foreign equity holders and, with capital mobility, reduces capital intensities locally. This is why Australian workers are disadvantaged – a recent study suggesting they lose $3 for every $1 of company tax collected. .

  15. @totaram
    I never suggested they could. When I said the ‘only source’ I figured you might be able to figure out who I meant.

  16. @Ikonoclast
    Thanks for that. My interest is really how people worry about deficits when we have probably 10% unemployment. Still wondering where the G20’s extra 2% growth is coming from.

  17. @Kel Y

    Yes, I would think both Keynesians and MMT-ers would agree a bigger deficit to stimulate demand would help reduce current unemployment. They would just disagree on the actual size of deficit required and the possible dangers of inflation. I tend to think if we asked John Quiggin, Bill Mitchell and some typically stupid (<- gratuitous sideswipe) neoliberal economist what the current deficit should be (considering we do still have a deficit) and then averaged the advice we would get a better setting than currently. This is provided none of the three knew the purpose of the question and thus did not skew their advice in an effort to nullify the others.

  18. Harry, I didn’t say current employees change their legal status to unincorporated enterprises. I said they change their status to companies (your term).

    Are you saying it is a good idea to have the legal system designed in such a way that the members of the set P (people) cannot escape their employee status and tax obligation while artificial persons (legal constructs, called corporations) operate tax free?

    What are the ‘factor returns’ and dividends?
    I assume you mean returns to L (ie wages) and returns to C (‘capital’) in the form of dividends and interest (ie a neo-classical macro model). But where is C in relation to the set P?

    What about retained earnings (and consumption on the job for managers)? Under the current legal system, on which your argument rests, incorporated enterprises would have a tax subsidy for growing their enterprises in comparison to unincorporated enterprises because taxes on retained earnings of the former may never be paid, either because the corporation goes bankrupt, is bought out by another one or lives on forever because the artifical person has no natural limit to its life. How would this affect market power concentration and would you like it? Why bother with ‘competition policies’?

    You also want lower taxes on ‘capital’. I am surprised. Was Thomas Piketty’s empirical research a waste of time? I do believe substituting L for P is a problem unless all members of the set P have the same endowment of ‘capital’. This condition on the distribution of ‘capital ownership’ is empirically grossly (no pun intended) violate as per Piketty and others (it is almost common knowledge for everybody who ventures outside their abode or reads newspapers or has any access to information on how other people live). [1]

    Dividend imputation does not fully distribute the so-called ‘factor returns’ because of retained earnings (and consumption on the job for managers). Dividend imputation is one way to reduce financial risk and resource wasting bankruptcy procedures because it reduces the incentive to substitute debt for equity under the ‘double taxation of dividends’ system. True, if all ‘company’ taxes were to be set to zero then this specific incentive problem would be removed but, as stated before, the growth in market power concentration would be tax subsidised.

    [1] In all general equilibrium models I know, from Arrow-Debreu to Geneakopolos et all, (including in my own on partially segmented markets with multinational firms) there is a minimum wealth condition. The purpose of this condition is to ensure that the idea of ‘freedom of choice’ is not an empty phrase. Do we really want an institutional environment (legal framework) which creates a class society under the name of ‘competitive market economy’?

  19. Ernestine, It doesn’t matter if the firms are incorporated or not. Taxes are paid on the incomes earned as you seem in fact to recognise when you get to your para 4. Fringe benefits on the job are taxed as income and retained earnings are retained for people who will pay taxes on them when they are unretained.

    The arguments you raise with respect to equity are addressed by changing the tax system’s progressivity not by double taxing company incomes by getting rid of imputation.

    Of course corporations do not operate tax free with zero company tax. The workers they employ pay income tax and the shareholders pay income tax. Other input suppliers pay taxes on the incomes they earn. The key effect of a zero company tax compared with the current imputation system is that returns to foreign investors improve to the levels of local investors. This means that the marginal product of capital equals a higher rate of return globally encouraging greater capital/worker and improving the returns to labour. As the Treasury paper on marginal excess burdens of various Australian taxes points out, the latter effect is very large.

  20. @derrida derider

    Early banknotes were redeemable for precious metal. Redemption was the process by which you could take a banknote to the bank or other issuer and receive in exchange for it a quantity of precious metal to the amount stated on the note; a guarantee of this was typically what was written on the note. If you had a banknote for ten crowns (or ducats, florins, guilders, marks, pounds, shillings, thalers, or whatever) you could redeem it for ten of whichever unit it was, in the form of precious metal. A thaler (or whatever) in precious metal was intrinsically a thaler; a banknote was a thaler (or whatever) only secondarily, by derivation, as a promise to pay the intrinsic thaler.

    This is no longer true. If you take a modern ten-dollar note into a modern bank and ask to redeem it for ten dollars, you’ll get nothing for it but some funny looks. The modern banknote is not redeemable for ten dollars, it is the intrinsic ten dollars.

  21. Harry, thank you for your reply. I can’t agree.

    To facilitate communication, I feel I need to say a few words which will probably bore you. Please have patience. There are non-economist readers of this blogsite too.

    1.” It doesn’t matter if the firms are incorporated or not.”

    The word ‘firm’ is the microeconomic textbook term for what is called ‘producer’ in general equilibrium models. In each case the words relate to ‘technological know-how’ that is required to produce something from combining other things in specified proportions (with GE models allowing many more possibilities than production functions in micro-texts). The former may be called ‘output’ and the latter ‘input’ in some contexts. In G.E. models (and in models of the core of an economy), the term ‘commodity’ covers ‘input’ and ‘output’ and more because a commodity is defined by its physical properties, time of availability, location of availability and state of nature conditional upon which it is made available. So, we are talking about ‘production technologies’.

    On the level of theory, it is not true that ‘it doesn’t matter whether ‘firms’ (production technologies) are jointly owned (corporation) or not. It does matter a great deal for the decision making problem, including risk taking. It is easy to reconcile ‘the firm’s decision problem’ with individual’s preference maximising decisions, including risk taking, for single owners, but not for joint ownership ‘firms’. See R. Radner on sequence economies with commodity and share markets, see J. Dreze regarding an analysis of the problem and the complexity of a Dreze-equilibrium and see GE models with incomplete markets.

    Empirically, the incorporation of investment banks (previously partnerships) is perhaps the most striking example of how the change in legal status, which allowed using other peoples’ money instead of their own, affects the behaviour of these actors, their role in the development path of the GFC and subsequent legal cases and fines. But the incorporation of ‘legal service providers’, ‘health service providers’, ‘education service providers’, and the associated change from a budget constrained professional service motivation to a corporate profit motive is also a rich source for information to not believe your assertion.

    Returning to step 1 in our discussion:

    The word ‘company’ belongs to the institutional (legal) environment, the language of lawyers, accountants and law makers. It is the legal framework which determines who in the set P = 1, …, n pays what taxes under which tax laws and it is not a theoretical result in neo-classical macro-economics. (No, the ‘contestable market’ and ‘privatise and regulate’ arguments don’t change this conclusion either. I am happy to be proven wrong in the context of a formal analysis.)

    In reply to my argument on how a change from the legal status of ’employee’ to ‘company’ can result in zero income tax revenue, given your proposal of zero company tax, you said:

    1a. ” No it doesn’t, the income the companies they form pay them is taxed as income. That’s what happens now with unincorporated enterprises. ”

    The word ‘enterprise’ may blur the notion of a ‘firm’ (producer) in economics with the legal notion of ‘an accounting entity’ but it does not blur the contradiction between 1. and 1a, IMHO.

    2. “The arguments you raise with respect to equity are addressed by changing the tax system’s progressivity not by double taxing company incomes by getting rid of imputation.”

    I can’t be sure whether you use the term ‘equity’ as in the sense of equity capital (share ownership) or in the sense of income and wealth distribution.

    But I can be sure that you do not acknowledge the relationship between dividend imputation and reduced financial risk taking behaviour of companies.

    Are foreigners, in whose interest you support the abolishion of dividend imputation, going to pay the taxes for future academics’ incomes? Or is the introduction of the words ‘knowledge workers’ supposed to be the answer to the first question?

    “This means that the marginal product of capital equals a higher rate of return globally encouraging greater capital/worker [ratios] and improving the returns to labour.”

    We have seen how this works in the GFC. I put it to you that the ‘marginal product of capital’ at the time of the Lehman Bros. event was a global negative at best and, at least for a short period of time it is best represented by a catastrophic point where all trades in ‘capital’ froze. How would you define a ‘marginal product’ at this point? I don’t know how to do it. The current Greek economic dilemma, known as the Greek debt crisis, is another example. Poerto Rico is another one.

    The financial notion of ‘capital’ is relevant for discussions on dividend imputation because we are talking about the distribution of company profits (accounting numbers) in currency values to holders of financial securities and not ‘marginal products’ of machines in operation.

    I can also be reasonably sure, but not completely, that you ignore the empirical findings on wealth and income concentration in Piketty. I am confident in saying (because I studied the book in question), that the underlying theoretical framework in Piketty is consistent with that of Radner’s sequence economy model and not a neo-classical macro-economic model. It doesn’t matter whether Piketty had this in mind or not because one can arrive at the same questions via different thought processes and it is quite ligitimate for the reader to sort the many bits and pieces of information in this voluminous work, “Capital in the 21 Century”, according to the reader’s prior knowledge. So, relative to the Radner model, Piketty partitioned the population P = 1, …., n people into those who receive only wages (L is a subset of P), those who receive income from ‘capital’ (C is a subset of P) and those who receive income from both (LC is another subset of P). He used a subset of the ‘global population’, picked by national juristictions such that for each country k, we get P(k) a subset of P. It is not a partitioning because data was available only for a few national juristictions and the data was not of equal length for all those examined. He used national accounts data, which means the institutional environment (laws, including taxation and accounting rules) are in the data. He then related the tme profile of incomes for the population segments to data on wealth by a version of the notion of ‘pay-back period’ in Finance. His policy recommendation – in principle – is: A wealth tax is required to curtail and reverse the growth in wealth inequality.

    What is the highest personal income tax rate required, given lower taxes on ‘capital’, to merely stop the growth in wealth concentration? I can’t answer this question, except to say it would have to be above 100% on some C incomes, some LC incomes with a tax free level of say $50000,– because this is a low estimates of the ‘production costs’ of the services provided by an ‘L’ person in Sydney treated as a company. (Income tax on individuals is levied on what would be called revenue for a company).

    3. ” … retained earnings are retained for people who will pay taxes on them when they are unretained”

    I might buy this argument if the life of a corporation would be linked to the life of a natural person and if you could provide empirical evidence that no company has ever gone broke. Otherwise not. Both conditions are empirically violated to such an extreme extent that no empirical study is required. Hence I don’t agree but note that retained earnings and there effect on the growth of enterprises as well as bunkruptcy costs are contained in the data used by Piketty.

    Harry, I am glad I am older than you because if institutional changes continue on the path they have been on since the late 1980s, the proverbial hitting the fan may occur at a time when I no longer care.

  22. @Ernestine Gross

    Is it necessary to let a system (the current system) generate inequality and then come along after the fact and tax (or tax extra) to redistribute wealth? Or would it be possible to create another less biased system which created less inequality in the first place?

    The market is actually a secondary issue. The institutions and laws of ownership under our current system are the primary problem. The minimum wealth condition first needs to be guaranteed by the institutional and legal system, specifically as citizen and worker (co-operative) ownership.

  23. C-D: ” If you take a modern ten-dollar note into a modern bank and ask to redeem it for ten dollars, you’ll get nothing for it but some funny looks.”

    You may get some funny looks if you take a ten-dollar note into a bank and ask to have it changed into 2 five-dollar notes but they will change it except if they are short of five-dollar notes in which case you’ll have to go to another one or come back tomorrow.

  24. On John Fraser: In fairness, maybe it’s a bit much to expect senior officials to be the discreet public servant one day and the expert commenter the next. If he was asked the same question at a Senate estimates hearing he would say, ‘Under the rules of the hearing you may not ask me my personal opinion of government policy.’ Maybe conference organisers and attending officials should just accept the same constraints.

    But agree that if those are to be the rules of the game, the officials themselves need to make it clear and be consistent. It’s not good enough to seek kudos as an expert one minute, as long as you’re saying what the boss agrees with, then run away as soon as you’re asked a pointy question.

  25. @Ernestine Gross

    I do not claim the reliability of a CD.

    Yes, a bank will change a ten-dollar note for two five-dollar notes if that’s what you ask, but that’s not the same as the former arrangement whereby banknotes could be redeemed for money as I described. Under that system, which I have already described, was that in the past a banknote derived its status as money from the fact that the issuer would exchange it for something (specie) that was understood by all to have a more fundamental status as money. When specie was exchanged for banknotes, the person who tendered the banknotes and received the specie could be said to be redeeming the banknotes but the person who tendered the specie and received the banknotes would not have been said to be redeeming the specie; the relationship was asymmetrical. You can exchange ten-dollar notes for five-dollar notes and you can also exchange five-dollar notes for ten-dollar notes, but the status as money of five-dollar notes and ten-dollar notes is equal; the relationship between the parties to the exchange is symmetrical and neither can reasonably be said to be redeeming banknotes (neither is receiving anything but more banknotes in the exchange).

  26. Geez it’s hard to follow the terminology in the argument between HC and EG about company tax if you are not an economist. But to put a simple question: if, as they did, a lot of economists found Piketty’s argument pretty convincing, how is not taxing companies on profit going to do anything other than exacerbate the issue Piketty identified? Or is HC allowing for a wealth tax of some sort on shareholders or corporations as a possibility within his argument?

  27. Steve, Currently excluding foreigners company tax on incorporated enterprises is just a withholding tax on the taxes that would be paid by shareholders. Because of imputation the shareholders are not taxed twice – once when the money is earned by the firm and again when it accrues to shareholders. That is as it should be in my view.

    The only impact of company tax outside this withholding tax role is on foreign shareholders who cop the company tax but don’t get the imputation credit.

    Thus the return on equity is boosted for resident shareholders relative to foreigners. But with perfectly mobile capital it is the return to these foreign shareholders that will determine how well the firm is equipped with capital. Firms will equate the marginal product of capital with the international return on capital less the company tax.

    Thus taxes adversely affect labour since wages paid to it will decrease if labour is more poorly equipped with capital such as machines. We know these effects are large and its the reason that most economists (probably not JQ) prefer low company taxes.

    Company taxes also distort local investment decisions toward local firms and distort the tax treatment of incorporated and unincorporated enterprises.

  28. Harry, you are totally ignoring that ‘financial capital’ consists of two parts, namely debt and equity. You are ignoring debt and hence the return to debt holders. This is the reason why you ignore financial risk. A lot more follows from that. For example, bonus payments to CEOs and other senior managers are usually linked to ‘return on equity’, directly or indirectly via options in the remuneration packages. The return on equity can be bumped up in the short term by taking on more debt (financial risk increases). In the long term, the CEOs are gone, the financial risk remains. (Remember the 1980s in Australia with Bond Corp, etc.?)

    Interest on debt is tax deductable. Under the system you are advocating, one gets what is called the double taxation of dividends (tax on company profits paid by the company and tax on dividends paid by shareholders. This is distorting the financing decision.

    At present US and to some extent in the EU and in Australia, the return on debt is very low (and the cost of debt for ‘enterprises’ is also low). This is the after effect of the GFC because of ‘quantitative easing’, primarily in the US. Money is parked in US Treasuries and Bunds (German government bonds) even though the yield – the secondary market determined rate of return obtained from trading the bonds with fixed coupon rates – was negative for some time. That is, the investors (buyers of these financial securities) paid monetary wealth for safe storage. At this point in time the tax deductions obtained from debt financing are low. This is not a permanent feature of ‘the global financial system’.

    The return on equity for shareholders is determined by both, dividends and capital gains (and losses). The capital gains (losses) depends not only on the earnings before interest and taxes of the companies with shares on issue but also on the leverage (debt) taken on by traders in equity shares (margin lending).

    I have never come across a ‘firm’ which equates ‘the marginal product of capital’ with the ‘international return on capital’. Even if such a calculation would be possible, the result would last for a period of time too short to make an investment decision involving physical capital which has a life span of years or decades rather than seconds, minutes, a few hours or at best a few days.

    There is no such thing as an ‘international return on capital’ to begin with and the ‘marginal product of capital’, where ‘capital’ relates to financial securities, is a fiction. There is a continuous process where traders in financial securities are trying to make a profit from searching for (often dirty) arbitrage opportunities. Moreover, the huge list of financial securities have different risk characteristics. Furthermore, they are denominated in several currencies (exchange rate risk). The financing decisions of multinationals is another specialised area of finance. They arbitrage internally.

    Some corporations work with a weighted average cost of capital. Others work with payback period (particularly in Asia) and in most cases the ‘cost of capital’ is determined by the board of directors at varying time intervals. It is the cost of capital (the discount rate used in NPV and IRR type project evaluations) which determine investment decisions in physical assets, the link to the returns on financial securities is not as presented in some textbooks because of the leaverage in the financial markets and, as is evidenced by the recent court cases regarding market manipulation of the Libor, by the banking system.

    “Thus the return on equity is boosted for resident shareholders relative to foreigners”. No, only the after tax rate of return on equity is higher for resident shareholders, not the return on equity per se, and only if the share issuing ‘enterprise’ pays taxes on profits made (‘fully franked’ and all this.)

    If you look at the size of the superfunds under management, there seems to be a lot of ‘capital’ which is waiting to find investment in ‘capital’ in Australia. Where are the manufacturing machines to be bought such that the argument about capital/labour ratio can be applied at all?

    Can you refer me to a paper which contains any theoretical or empirical results you appear to have in mind?

  29. Printing money, Nathan, IS borrowing. A banknote is a Treasury bond redeemable at call, paying 0% nominal interest. If the government issues more money it owes more.

    When the Australian Government issues currency it is true that it is issuing an IOU to the domestic non-government sector. If you have $100 it means the government owes you $100 worth of tax obligation extinguishment if you choose to use the $100 in payment of taxes.

  30. @Nicholas

    Government “money printing” of fiat money is not borrowing by definition. If they borrow it they are not “printing it”. If they borrow it, it works like this below as for all commercial bank loans.

    “In the contemporary economic system, most money in circulation exists not as cash or coins but as bank deposits. The main way in which those bank deposits are created, is through loans made by commercial banks. When a bank makes a loan, a deposit is created at the same time in the borrower’s bank account. In that way, new money is created as a bookkeeping entry, with the loan representing an asset and the deposit a liability on the bank’s balance sheet.” – Wikipedia.

    A government can expand money supply by this process. However, bank money always has a corresponding debt so bank money is extinguished when it is repaid. Money supply can be expanded in a growing economy solely by this process as new loans are made faster than old loans are extinguished.

    When a government truly “prints” fiat money there is no real corresponding debt though there might be various kinds of window-dressing accounting. The government can credit commerical accounts at a keystroke without borrowing anywhere. They are just numbers. This new fiat money is only extinguished when taxes exceed outlays (a budget surplus). In essence though, all dollars look the same once in circulation and one cannot say of a dollar being extinguished by loan repayments or by tax payments that it is a bank dollar or a fiat dollar.

  31. @hc

    Thank you for the reference. I had a quick look. It apparently deals with static ‘representative agent models’. I need to read the entire paper to be sure that this type of model is entirely useless for the topic in question. I’ll come back to it.

  32. > A banknote is a Treasury bond redeemable at call, paying 0% nominal interest.

    In what sense can something be said to be “redeemable” if the act of redemption consists of swapping item A for an item that legally and practically cannot be distinguished from item A?

    Constructing bank notes as loans made sense when money existed in other-than-banknote forms, but nowadays that’s just silly.

  33. @Collin Street

    “In what sense can something be said to be “redeemable” if the act of redemption consists of swapping item A for an item that legally and practically cannot be distinguished from item A?”

    In the sense that it distinguishes fiat money from other types of financial securities.

  34. @hc

    Harry, thanks once again for the link.

    Having read the paper you linked to, I see no need to revise my previous posts. Had our discussion been based on this paper from the beginning, the style of discourse might well have been different, although possibly more esoteric.

    The paper contains results from and discussions of a static ‘representative agent general equilibrium model’ and a ‘comparative static result’ for a small set of ‘marginal’ changes of tax rates. There are some sensitivity results for some parameter values.

    The authors acknowledge several shortcomings of the specific model in relation to some other versions (dynamic and overlapping generations models), which are not available as yet at the ATO. They also acknowledge the advantages of simulation models (presumably simulation of agent models) and, at various points in the paper, the authors acknowledge their results may overstate or understate so-called ‘wellfare benefits’ and ‘excess marginal tax burdens’’).

    I’ll focus on the major points of disagreement and then make a few remarks about the methodology in general..

    1. Treatment of people in the model.
    The term ‘representative agent’ means there is only 1 consumer in the model. In terms of my discussion, the set P (people) has 1 element. A discussion of the income distribution in terms of the subsets of P, namely L, C, LC is therefore ruled out in the proverbial line one. The results of the model cannot be linked to Piketty’s work.
    While this model is named a ‘general equilibrium model’, it does not contain the minimum wealth condition which is crucial in theoretical models that bear the name general equilibrium. See footnote on my post.

    2. Taxation
    The personal income tax rate for income from wages and ‘capital’ is assumed to be 30%.
    For later purposes, I note that this assumption is already violated by the progressive tax structure we have and by negative gearing and capital gains tax concession on real estate investment by private individuals.

    3. Financial risk
    The model assumes the debt/equity ratio of companies is fixed. This excludes the financial risk considerations of double taxation of dividends about which I talked by simply excluding the empirically relevant issue by assumption.

    3. Systemic financial risk
    The treatment of the contemporary international financial system (private debt generation without bounds, leading to financial crises, bailouts at tax payers expense, market manipulation, ….) in this model is extremely naïve in the sense that it doesn’t enter the model at all.

    On the contrary, the model specification is such that the international financial system dictates the required rate of after tax return to Australia and everything else has to adjust. Since the model imposes ‘market clearing’, wages (for the 1 individual!!) have to adjust.

    4. Retained earnings
    I couldn’t find anything specific on this item. But my point remains due the methodology.

    5. Methodology
    The reader may wonder by now who this one ‘consumer’ is in real life. Is it the Treasurer, is it a voting age student, … who is it? The answer is that except by pure chance, the ‘utility maximising budget constrained individual’ does not exist in reality. A similar argument applies for the ‘firms’, although the model allows for some variations among ‘firms’ and their tax treatment and it even makes an attempt to differentiate between domestic and multinational firms.

    The reason for the foregoing is that the model is ‘calibrated’, that is, the equations in the model are fitted to national accounting and unpublished ATO data to ‘make markets clear’ (ignoring involuntary unemployment, environmental issues – which render even the theoretical conditions of a ‘representative agent model’ invalid – and a few more.)
    The authors state that, in contrast to partial equilibrium models, general equilibrium models take flow on effects in other markets into account. This is true on the level of theory but not for this applied model.

    So, to the best of my knowledge, the retained earnings are not ‘un-retained’ anywhere. They are hidden in the aggregated and averaged data for the firms. Hence the problem of market power concentration I raised is not refuted.

    Finally, a static comparative result means one does not know or model how one gets from point A to point B but if one were at point A and if one were at point B then one can say something about the difference. This is the same as saying one is comparing two different economies at the same time (because the adjustment process is not known).

    PS: The paper also uses the term ‘distortion’ when talking about investment decisions and taxation. I suppose by now this term is a convention which should be ignored because with respect to what is something ‘distorting’ and, moreover, relative to reality, surely taxes are supposed to ‘distort’.

  35. This paper is about estimating marginal excess burdens for various taxes. The weakness is that it cannot say anything sensible about income taxes because there is only one consumer. I also have problems with computable CGE models that are “calibrated”. But most of the results here are consistent with the vast literature on optimal excises and other taxes. I think the taxes they find highly distorting – e.g. the company tax – are generally observed to be so in the literature.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s