For an academic, one of the great things about blogging is the help it provides on questions I would otherwise spend a lot of time trying to answer (I hope those readers who act as unpaid research assistants from time to time feel they are getting fair value from my efforts on the blog) .

I’m currently in need of some suggestions. I’ve posted a few excerpts of my chapter on economic policy under Howard (it’s for a book to be edited by Robert Manne), and I need to give some suggestions for further reading, accessible to that elusive character, the general intelligent reader. I’d say the readers of this blog come as close as anyone I’m likely to find in this respect. Any suggestions? Books would probably be preferred, but articles in easily accessible journals would also be OK.

Among the questions raised on the Monday message board is one where the answer is, in the words of Ronald Reagan, simple but not easy. The correct way to deal with stamp duty on house purchases is to scrap and replace revenue by scrapping the land-tax exemption for owner-occupied housing.

The current system discriminates in favor of existing home-owners against homebuyers. But since the interests of existing home-owners represent the most sacred of Australian sacred cows, I can’t see this changing.

Apparently, the housing affordability problem has been all the rage while I’ve been away. Coincidentally, I’ve been looking at the housing bubble as part of my study of economic policy under Howard. Your comments on this would be much appreciated. Here it is

More than any previous government, the Howard government has tied its economic and political fortunes to the performance of the housing market. Activity in the housing market boomed in the leadup to the GST, as builders and households sought to complete as much work as possible before GST became payable. This boom was, naturally enough, followed by a slump in the immediate aftermath of the introduction of the GST.

The government responded vigorously and effectively, doubling the grant to first homebuyers that had been introduced to offset the impact of the GST. The fact that this measure was available for a limited period fuelled a rush mentality which persisted even after the grant was reduced to its original level.

The homebuyers grant was followed in late1999 by a cut in capital gains taxes., which are now taxed at half the rate applicable to ordinary income. Although this measure gutted an important reform introduced by the Hawke-Keating government, it received the enthusiastic support of the Labor opposition.
Although this measure was meant to encourage participation in the so-called Înew economyâ represented by the then-booming NASDAQ stock market, it had barely taken effect when the dotcom bubble burst. Instead, it helped to inflate a bubble in investment properties, particularly unit developments marketed to small investors who could exploit the benefits of negative gearing (taking tax deductible losses from a rental property in the expectation of realising a concessionally-taxed capital gain).

Read More »

This light-hearted piece by Daniel Akst from the NYT raises a lot of important points about prudential regulation, quangos and related issues.

For those not familiar with the cute nomenclature of US financial markets, Fannie (Mae) was a nickname for the “Federal National Mortgage Association”, but now appears to be its official business name. Freddie (Mac) was the Federal Mortgage Acceptance Corporation, or something like that. Both are stockholder owned corporations, established with a special government charter.

In other words, these are quangos in the original sense of “quasi-non-government organisations”,private business organisations, established with effective government backing, to perform what would normally be regarded as public functions.

Among the many problems with quangos, the one emphasised in this article is the implicit guarantee from governments to bail them out if they get into too much trouble. A very similar system applies to banks under the Australian system of prudential regulation. As I observed here

Most Australians would be even more surprised to discover that there is no public guarantee of bank deposits. Under current policies, the government does not guarantee deposits, but does nothing to dispel the general belief that such deposits are absolutely safe.

As Akst observes, this kind of implicit guarantee is the worst of all possible worlds. Governments should either
(i) withdraw the guarantee;
(ii) charge a commercially-sound fee, as in deposit insurance schemes; or
(iii) take ownership of the enterprise
Akst suggests taking Fannie and Freddie into public ownership, getting their books in order and then privatising them without the implicit guarantee. This is probably the best strategy in this case.

This SMH report says the GST has done nothing to reduce the size of the hidden economy. I haven’t seen the original research on which the report is based. Also, although the reported method of looking at the volume of “unexplained” cash is widely-used in the literature on tax evasion, I have some technical difficulties with it. But the basic result is entirely predictable, and was in fact predicted by every competent economist who looked at the problem. Simon Grant and Stephen King (both then at ANU) did a nice analysis and someone else (can’t recall name right now) published much the same thing in the Economic Record.

I gave a less formal exposition in the Financial Review in 1996. The key point

The silliest of the claims made in support of substituting a GST for income taxes is that it will put a stop to tax evasion, of the kind practised, for example, by plumbers who are willing to charge a lower price in return for payment in cash. It should be obvious, at least to anyone trained in economics, that a change in names will change nothing; plumbers who fail to report their income to the Tax Office will also fail to report their sales to the officials responsible for the GST. For those who prefer a formal general equilibrium analysis, a paper by Simon Grant and Steven King proves that replacement of an income tax by a GST will make no difference in the extent or incidence of tax evasion.

It looks as if the data is finally in on this one.

I’m writing a chapter for a book on the Howard government, in which I’m assessing its economic policies. Here’s my draft conclusion (comments much appreciated).

The experience of seven years of nearly uninterrupted expansion under Howard, following three or four years of tentative economic recovery under Keating has given the government a reputation for good economic management. This reputation has been reinforced by the maintenance of low interest rates.

It is hard to see, however, that the government has contributed much to these outcomes. As in standard nowadays, the Reserve Bank is primarily responsible for the maintenance of macroeconomic stability. The Reserve Bank has judged monetary policy well since the mid-1990s, and, as a result, Australia has gradually recovered the ground lost in the 1989-92 recession.

But whereas the then Treasurer, Paul Keating, must share significant responsibility, along with the Reserve Bank, for the disastrous misjudgements that gave us ‘the recession we had to have’, the current government can claim little credit for the correct judgements of the Reserve Bank. It cannot even claim credit for not interferign. The policy of central bank independence has turned out well in Australia in the last, but it failed badly in New Zealand, where bad monetary policy contributed to a string of recessions in the 1990s.

In its first term in office, the government claimed credit for the decline in interest rates on the basis that the tight fiscal policies associated with the 1996 Budget cuts. The merits of the ‘crowding out’ hypothesis underlying this claim are debatable, particularly in a world of unrestricted capital movements.

More importantly, the government has abandoned any claims to fiscal rectitude since 2001 when it dissipated what remained of the budget surplus, Since then, the government has more or less officially adopted a zero budget balance (on whichever of the various accounting systems seems most appealing in any given year) as its target. This policy ensures that an economic downturn will produce large budget deficits and a substantial reduction in public sector net worth. If the government took its own rhetoric about fiscal prudence seriously it would be running surpluses to prepare for such an event.

Similarly at the microeconomic level, it is hard to see any basis for claims of superiority in economic management. The government has neither produced an alternative to the microeconomic reform agenda of its predecessors nor made any significant contribution of its own beyond the completion of unfinished business and some desultory swipes at the trade unions.

In retrospect, it seems likely that the long expansion of the 1990s will be viewed as a missed opportunity. Such a period of economic stability does not come along very often and is unlikely to persist indefinitely. Yet Australia has surprisingly little to show for this long period of prosperity, except for massive additions to an already impressive stock of housing, now valued at equally impressive prices. Unemployment has fallen a little but is still above the low points reached in previous expansions. No new initiative has been made to deal with the problems of financing retirement for an aging population; there has not even been much progress in tidying up the tangled web of policies inherited from the Keating government. The most important single investment in the future is education: if anything, we have gone backwards in this respect, particularly in relation particularly in relation to post-secondary education, the main area of Commonwealth responsibility.

In 1964, Donald Horne described Australia as ‘a lucky country, run by second-rate people who share its luck’. This epigram could be applied, with equal or greater justice, to the Howard government and its term in office, particularly as regards economic policy. Sooner or later, however, this kind of luck will run out.

Update Lots of useful comments already! I’m grateful for substantive, stylistic and typographical corrections and suggestions. As well, the comments thread has some good discussion of things like measures of unemployment. I’m very encouraged by this and will probably post more.

The New Zealand Labour government has confirmed that it will renationalise the country’s rail network. The Blair government in Britain did the same thing last year. In both cases, the decision reflected the failure of the private operator to deliver the expected outcomes rather than an ideological commitment to public ownership.

It is becoming increasingly clear that attempts to determine the optimal role of the public sector on the basis of an a priori ideology, such as old-style socialism or neoliberalism, are bound to result in bad policy decisions.

As part of my research on higher ed, I checked out statistics on student numbers and other things collected by DEST. A particularly striking figure is that on commencements by non-overseas students. This series rises steadily until 1996 (to about 230 000) then stops.

Here’s the table

1992	1993	1994	1995	1996	1997	1998	1999	2000
194,746	200,709	206,202	221,531	233,310	232,890	229,420	231,392	231,992	237,960

Commencements are a more sensitive indicator of responses to policy changes than student numbers, and this certainly tells the story of human capital investment under the present government, or at least in the Kemp period covered by the data set.

Over the same period, the number of Full-Time Equivalent academic staff actually declined, continuing a decline in staff-student ratios that began under Labor (the picture is worse than it looks at first glance because overseas student numbers have been rising).

So, we’ve got a smaller proportion of the population going to university, and receiving a lower-quality education. This is the same story as we got from reform of school education in the early 1990s notably under the Kennett and Olsen governments. Whatever short-run improvements in measured productivity have been extracted from micro-economic reform will be more than offset by lower investment in human capital.

My column in today’s AFR (subscription required) is about financing renewed investment in universities. Here’s an extract.

What is needed is a large-scale capital injection. In a budgetary environment still dominated by cash accounting, this is unlikely to be provided out of general revenue. However, there is one big asset associated with the university sector that could be used to finance new investment. The student debt accumulated under HECS amounts to between $5 billion and $10 billion, depending on how it is valued.

This debt is treated as an asset of the commonwealth but it ought to be regarded as a contribution to the university system from graduates. Bonds secured against the HECS debt and serviced by the associated flow of HECS repayments could be used to finance new investment in higher education, repairing the shortfalls of the past decade. To ensure equitable access to funds, universities could be aggregated into funding groups, each representing a mix of university types (old-established sandstones, former institutes of technology, former CAEs, regional universities and so on) with different endowments of assets.

Although borrowing against the HECS debt would provide a flow of investment funds in the medium term, it would not change the fact that, ultimately, public expenditure must be financed by taxation. HECS repayments used to service higher education bonds would not be paid into general revenue as at present.

More than any other activity undertaken by society, education embodies the obligations of each generation to the next. Explicit recognition of student contributions as a basis for future investment in education, rather than a mere user charge for consumption of current services, would contribute to social cohesion as well as yielding a social return as high or higher than any alternative investment available to governments or individuals.

Update Andrew Norton disputes my claim about social cohesion. I don’t see a need to change what I’ve written in response.

Ross Gittins is excellent, as usual, in his latest piece on the housing bubble. He points out that most unit investors have put their own homes up as collateral and stand to lose them if prices decline sharply (say by 40 per cent). But I have a quibble about his conclusion, saying that, if this happens

the Howard Government’s reputation as incomparable economic managers might be looking pretty tarnished.

If so, it would have only itself to blame. Why? Because it left open the negative-gearing loophole on which this whole rocky edifice has been built. And then it compounded its failure by halving the tax on capital gains. I call that asking for a property boom. As Gittins explains, negative gearing involves taking tax-deductible losses on rental property in the hope of getting a capital gain taxed at half the normal rate.

The fundamental problem here is not the tax deductibility of losses but the concessional treatment of capital gains. In principle, at least, losses should be tax deductible. The practical problems are those of bogus losses and avoidance/evasion of tax on the associated income. But where possible, it is better to tackle these problems directly than to make particular categories of loss nondeductible.

The government certainly deserves blame for the decision, taken at the height of the dotcom mania, to halve the rate of capital gains tax. But Labor must share the blame for going along with this. As I wrote at the beginning of 2000.

Unfortunately, the Labor Party has decided that it can win the next election on the basis of the government’s difficulties with the GST, while proposing little more than cosmetic changes if elected.

Whether this is a viable political strategy is not for me to say. But it has already had disastrous effects on tax policy. In order to clear the way for a opportunistic campaign on the GST issue, Labor aided and abetted the government in destroying one of the Hawke-Keating government’s most important reforms, the taxation of capital gains on the same basis as other incomes.

The implementation problems associated with the GST will pale into insignificance compared to those that will arise from this cynical deal. The tax avoidance industry and the courts will be kept busy for years dealing with attempts to convert taxable income into capital gains. Moreover, the policy will favour heavily leveraged speculative investments at the expense of real investments generating taxable income. The danger of a speculative bubble, leading to an asset price boom and slump, will be enhanced. …. (emphasis added)
(The mysterious, and not entirely accurate, term ‘negative gearing’ can be parsed as follows. ‘Gearing’ refers to the ratio of debt to equity, which is approximately proportional to the ratio of interest payments to net returns. If interest payments exceed gross returns, net returns become negative, and the ratio becomes meaningless).

I’ve appended a bit more of the article below for anyone interested

Read More »