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. @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.

  2. 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.

  3. 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.

  4. @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).

  5. 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?

  6. 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.

  7. 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?

  8. 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.

  9. @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.

  10. @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.

  11. > 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.

  12. @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.

  13. @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’.

  14. 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.

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