Productivity Commission re-litigates road pricing reform

In situations where demand exceeds supply, a good or service can either be rationed by queuing or rationed by price. Economic theory is clear that it is most efficient to ration by price, as the good or service goes to those with the highest willingness to pay, that is those who place the highest value on the good or service. So we rely on the price mechanism to efficiently match supply and demand for large parts of the economy, but not for all. As Productivity Commission Chair Peter Harris noted in a speech yesterday, we largely do not use the price mechanism in relation to Australia’s $280 billion of road assets (see The case for infrastructure pricing reform: what water can teach roads). This means that, during peak hour, the scarce space on our arterial roads is rationed by queuing, that is via traffic jams.

Peter Harris has previously argued the case for a greater use of road pricing on all roads, not just new ones, given that it is technologically feasible to do so and there would be large efficiency gains, as I have also argued in previous posts on congestion charging (e.g. RACQ should push for demand management options such as congestion pricing). Mr Harris noted with respect to our practice of only allowing charges on new toll roads that:

…charging to use the new, more efficient road while leaving the old roads system as an apparently free good is not necessarily supporting efficient resource allocation.

Road pricing reform would lead to better outcomes in the short-term, through reduced congestion in peak hour, and in the long-term through encouraging the right investments to be made in the roads system. At the moment, new toll roads can find it difficult to compete with the free road network. So road pricing reform would be likely to revive interest in road projects by a private sector that is wary given the recent troubled history of toll road projects (e.g. Clem7 and Airport Link).

While the Prime Minister has previously rejected the Productivity Commission’s ideas on road pricing reform (see this ABC News report), I’m very glad Peter Harris has not been deterred and is re-litigating the case.

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GST much more efficient way to raise revenue than income tax

Flavio Menezes, Economics Professor at the University of Queensland, has an interesting piece at the Conversation fact checking a bold claim by federal MP Andrew Leigh that the GST is as economically inefficient as the income tax and less equitable as well. I think everyone agrees the GST is less equitable,  and hence a GST hike may require some compensation for low-income earners, so let us focus on the economic efficiency issue, on which I disagree with Andrew Leigh.

Flavio, however, concurs with Andrew Leigh, noting that he has correctly cited a recent Treasury finding regarding the economic efficiency costs (a.k.a. deadweight losses or excess burdens) of the GST and income tax, both around 20 cents for every dollar raised. These efficiency costs come from the distorting impact that taxes have on economic behaviour, particularly through decreasing the attractiveness of work relative to leisure, which both the income tax and GST do (as the GST raises the prices of goods and services purchased using income typically derived from working).

The problem with relying on the recent Treasury study is that, as the Treasury itself acknowledges in the paper, its estimate of the efficiency loss from the GST is much higher than previous findings (e.g. a range of 8 to 13 cents per dollar raised in studies from KPMG and Independent Economics as shown in the chart below). The Treasury cannot explain the reason for this discrepancy, noting rather obscurely (on p. 39 of the Treasury working paper) that “subtle variations in model calibration can affect the relative marginal excess burden of the GST.” My reading of the Treasury working paper is that the Treasury is not particularly confident in its finding. Hence, I would suggest that Andrew Leigh should not be relying on it to make such a bold claim about the GST.

meb_gst

It is clear from basic economic logic that a GST would be a more efficient way to raise revenue than the progressive income tax that Australia has. Economists have long known that raising revenue using a broader base with a lower tax rate is more efficient. This is because the efficiency cost of a tax increases more-than-proportionately with the tax rate, as John Freebairn notes in his review of Flavio’s fact check. For example, a 20 per cent tax rate has more than twice the efficiency cost of a 10 per cent tax rate. Broadly speaking, this is because as tax rates increase they start discouraging greater amounts and increasingly more valuable amounts of economic activity.

The virtue of the GST is that it extracts taxation revenue from a very large number of Australians using a relatively low tax rate. The vice of the income tax is that it extracts great amounts of revenue using a relatively high tax rate from a much smaller number of Australians than the GST. As the Treasury Secretary recently noted in his Australian Conference of Economists 2015 lunchtime address:

Currently, the top one percent of taxpayers who pay the top marginal rate contribute 17 per cent of all personal income tax.

And the top 10 per cent contribute 46 per cent of all personal income tax.

Over the next decade more Australians will move into the top tax brackets.

The proportion of taxpayers in the two highest tiers is expected to increase from 27 per cent to 43 per cent in 2024-25.

The Treasury Secretary noted that this discourages labour supply at the top end, encourages talented Australians to work and take their valuable innovations overseas, and encourages aggressive tax planning to minimise tax. It seems obvious to me that raising revenue through our current income tax regime comes at a very high cost, and that we should consider a change in the tax mix, with greater reliance on the GST.

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Lessons from John Howard’s GST reform suggest current tax reform process will most likely fail

At a panel discussion on tax reform in Brisbane last night, there were some important insights for the current taxation debate made by former PM John Howard’s economic adviser Peter Crone, Australian newspaper contributing editor Professor Judith Sloan, and Griffith’s Alex Robson. Peter noted that one of the motivating factors for the State Governments having accepted the GST in the late 1990s was that they were faced with a huge loss of revenue, some $5 billion, from a 1997 High Court case that ruled some so-called business franchise fees were actually excise taxes and constitutionally invalid for the States to impose. So there was a real urgent and obvious need for a GST from the perspective of the States. Given the lack of a similar historical context at the moment, in my view, any changes to the GST are highly unlikely, and indeed GST reform is being opposed by the Victorian Government, practically ruling it out in the short-term.

Peter provided five lessons based on his experience in John Howard’s office during the development and implementation of the GST:

  1. Use the economic and political cycle – i.e. do it when people are not anxious about the economy and the Government has political goodwill and vigour in its early years (my words in interpreting Peter’s point),
  2. Get the case right and use the evidence – i.e. do the number crunching and explain it to the public,
  3. Policy proposals have to be debated and there must be community consultation,
  4. Compensate the losers, but not too much – e.g. the Howard GST reform compensation package broadly matched the expected and ultimate CPI increase from the GST, and
  5. economic reform demands leadership, courage and communication – i.e. qualities that politicians of a past age such as John Howard and Paul Keating were blessed with, but which seem sadly lacking in today’s politicians (again, my words in interpreting Peter’s lesson).

Judith Sloan picked up on Peter’s last point and noted that she rejects the view politicians need to be careful they do not spend all their political capital on reform. She argued that instead they need to build up political capital by developing and prosecuting the case for reform. Judith also noted that with tax reform “the devil is in the detail”, and argued we need to distinguish between a debate over changing the tax mix (a legitimate debate) and increasing the tax burden (a debate we should not have, given the tax burden is already high).

On whether Australia has a revenue raising or spending problem, Alex Robson earlier in the night reiterated the point he made at the Conference of Economists a couple of weeks ago that the problem is not revenue, which for the Commonwealth was around its long-term average (since the early 1970s) of around 23.5 per cent of GDP, but expenditure, which at around 26 per cent of GDP in 2014-15 has been higher than the long-run average of 24.2 per cent (see chart below).

Commonwealth_receipts_payments

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RBA to address ESA Qld seminar on recent labour market developments

wage_price_index_Mar_2015

As Australia has experienced below-trend economic growth recently, and the unemployment rate has crept up to around 6 per cent, reducing the bargaining power of employees, wages growth has fallen (chart above). This in turn has contributed to relatively low inflation, giving the Reserve Bank of Australia some scope to cut the cash rate further, although it would need to consider the risk of further inflating the Sydney property price bubble. Given this context, it would be timely to hear from the RBA on recent labour market developments, and it so happens that a senior RBA official, Christopher Kent, is scheduled to address an Economic Society of Australia (Qld) lunchtime seminar on Friday 14 August:

Christopher Kent – Recent Labour Market Developments

The registration fee for the seminar will be $15 for members and $25 for non-members, which will help cover the costs to ESA (Qld), of which I’m the Secretary. You can register by getting in touch with the Secretariat (admin@esaqld.org.au).

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Qld Govt expenditure growth has resumed after extraordinary period of austerity

The debate over the 2015-16 Queensland Budget continues, with the Courier-Mail publishing an opinion piece by State Political Reporter Steven Wardill, Today’s problems in Queensland bigger tomorrow after Budget, say economists, quoting me and fellow economist (and friend and former colleague) Joe Branigan. I have previously expressed my concern about several of the Government’s budget measures, such as the accounting trick of transferring general government debt to government-owned businesses. Also, I’ve criticised unnecessary and avoidable expenditures (e.g. $100 million for the Townsville sports stadium) and the resumption of growth in public service numbers, at a rate of 3,000-4,000 extra public servants each year.

While forecast expenditure growth seems modest compared with the unsustainable growth over much of the 2000s (see chart below), in my view it should be much lower so the Government can generate the large surpluses it needs to substantially pay down debt. The previous Government showed that extreme expenditure restraint is possible, although two years of practically zero expenditure growth probably contributed to that Government’s eventual election loss, so I doubt any Government will be that courageous in the future.

Qld_gg_spending

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Right diagnosis from Qld Treasury on Qld’s debt problem, but wrong prescription

The Review of State Finances (see p. 80) produced by Queensland Treasury to inform the 2015-16 Budget is clear that Queensland Government “debt is too high.” The Treasury acknowledges that the State’s balance sheet is not “in a position to absorb a significant shock without a credit rating reaction and/or the need for corrective measures.” Treasury is also concerned that our borrowing costs could blow out when interest rates return to more normal levels.

Having acknowledged Queensland’s serious debt problem, oddly, the Treasury recommends a very slow, medium-term, ten-year debt reduction strategy, implying a lack of urgency and raising the likelihood the necessary debt reduction is never achieved. This is especially the case given the possibility of a shock within the next ten years that compromises our balance sheet (e.g. what if there is an economic or political crisis in China?). Treasury should have recommended strong expenditure restraint over the forward estimates and should have resisted the surge in public service numbers.

I was interviewed by Steve Austin on 612 ABC Brisbane radio yesterday morning concerning my reaction to the State Budget:

Queensland Budget reaction

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Qld economy propped up by residential building as business investment slumps

The Brisbane Times has a report this morning on the well-known slump in business investment in Queensland, due partly to the completion or near completion of the LNG projects at Gladstone and partly to relatively low business confidence (see Qld Budget papers show business investment nosedives). Fortunately, residential building is recovering (see chart below based on new ABS data released yesterday), and this is helping Queensland avoid a further economic downturn that would see the unemployment rate increase above the stable rate of 6.5 per cent that Queensland Treasury is forecasting for the next two years.

workcommenced_Mar15_chart1

As you might expect from all the cranes over Milton, West End and Newstead in Brisbane, the residential building recovery is driven by construction of apartments and townhouses (see chart below).

workcommenced_Mar15_chart2

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