Huge financial sustainability challenges for Qld’s remote Indigenous councils

Queensland’s remote Indigenous councils are facing huge financial sustainability challenges, with the councils typically running large operating deficits, averaging nearly 20 percent of revenue, and running down their asset base to survive (see figure below), according to the Queensland Audit Office’s financial audit report for Councils released last Thursday (also see this Brisbane Times article Qld Council’s are more than $5 billion in debt).

QAOpost_scatterplot

While the Indigenous councils have negative net financial liabilities (i.e. they have net financial assets), this may be because of previous grant money they have received from the federal and state governments, which the councils are running down over several years. The councils appear to be strongly reliant on grants to fund their operations and to avoid accumulating massive debts.

The large majority of councils that were assessed by QAO as being of higher relative financial risk are Indigenous councils (figure below). Nine Indigenous councils are in the higher relative risk category, seven are in the moderate relative risk category, and only one, Hope Vale, is assessed as lower risk.

QAOpost_barchart_riskassessment_2

The Indigenous councils at higher relative risk are located in Far North and North West Queensland, mostly in Cape York (Map below). Their remoteness adds to the challenges they face. The QAO provided the following concise summary of the challenges facing Indigenous councils (p. 4):

Indigenous councils have a higher risk of becoming unsustainable compared to the other council segments. This is due to their inability to raise their own revenue and their reliance on grant funding. Costs of living in these council areas are also higher due to the remoteness of their locations.

The inability to raise revenue is related obviously to limited economic development in remote Indigenous communities. Unfortunately, government policies to promote Indigenous economic development and well being have been largely unsuccessful, partly related to a lack of critical evaluation and reflection on policy initiatives, as argued by Sara Hudson from the Centre for Independent Studies in Mapping the Indigenous Program and Funding Maze.

QAOpost_Map_Qld

Finally, I should note the QAO report shows that many Queensland councils appear to be performing reasonably well financially: 45 out of 77 councils ran operating surpluses and had net financial liabilities below 60 percent of revenue, the QAO’s recommended limit. Queensland councils appear very averse to debt, and it is mostly larger councils, namely Brisbane, Ipswich and Townsville, that have net financial liabilities in excess of the QAO’s recommended limit of 60 percent (see chart below).

QAOpost_NFL_Population

 

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4BC Dora the Explorer interview & ABC News coverage of my CBIC analysis

Dora the Explorer interview with Ben Davis on 4BC

Yesterday afternoon I had an enjoyable chat with Ben Davis on his 4BC wireless show Brisbane Live regarding the state government’s use of taxpayers’ money to lure the live action Dora the Explorer film production to Queensland:

Do subsidies work?

Note there is some great commentary from Ben on the relevant issues prior to when I come on at around 5 minutes in, although I do disagree with Ben on whether state government assistance should be provided. Here’s the nice concise summary of the interview on the 4BC website:

The exact amount the Palaszczuk Government will subsidise the project is commercial in confidence, but former Commonwealth Treasury Manager and Principal at Adept Economics, Gene Tunny, has done the sums and believes the number’s extremely generous.

ABC coverage of my analysis of CBIC’s investment mandate

Today, my analysis of the City of Brisbane Investment Corporation’s investment mandate is featured in an online ABC News article by up-and-coming ABC reporter Tim Swanston:

Brisbane risking $270m in ratepayer funds with secretive investment strategy, economist warns

The article begins:

There are growing concerns that Brisbane City Council’s investment arm is risking $270 million of ratepayer funds with an investment strategy kept at arm’s length from the city’s residents.

Economist Gene Tunny is echoing the concerns of Opposition and independent councillors that the City of Brisbane Investment Corporation (CBIC) has concentrated its investments too heavily in the property sector, risking heavy losses in a downturn.

Relevant previous posts

Previous posts of mine on film industry assistance and CBIC include:

Weekend reading: CIS Policy mag featuring my article on film industry subsidies

Ragnarok in Brissywood

CBIC’s peculiar investment philosophy

Croquet club blunder another reason to shut down BCC’s future fund

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Fair Share is overly pessimistic and interventionist, but still worth reading

Last Wednesday night I was fortunate to attend the Fair Share book launch at Brisbane’s historic Customs House. Unlike many book launches it was widely reported (e.g. this SMH article), as the book was launched by former Prime Minister Paul Keating, who described inequality as a “cancer and a curse” and argued “liberal economics is going nowhere.” His address was consistent with the main themes of Fair Share: Competing Claims and Australia’s Economic Future, written by University of Queensland Professor of Political Economy Stephen Bell and former head of the Department of Prime Minister and Cabinet, Michael Keating, no relation to our former PM. The book warns of growing inequality and social dislocation caused by disruptive technological change, including automation and artificial intelligence, and argues the solution is greater government intervention, including an activist fiscal policy and more redistribution.

keating.jpeg

Former PM Paul Keating launching Fair Share at Brisbane’s historic Customs House

The message from the authors, who also spoke at the launch, is that bigger government is necessary to prevent us from becoming the highly unequal and divided society America is today. One of the authors suggested Australia needs to position itself in the middle of the OECD in government expenditure, half way between where we sit now, similar to the US at 36-37 percent of GDP, and the Scandinavian economies at 50+ percent of GDP (see these OECD data). This would mean Australia would have government spending of 43-44 percent of GDP, meaning additional government expenditure of over $120 billion per annum, or nearly $5,000 per Australian.

Obviously, this would involve a large increase in taxation, and the burden would no doubt be disproportionately shared, with higher income earners bearing the bulk of the burden. Incentives for work and entrepreneurship would be reduced, and tax avoidance would be further encouraged. Anyone proposing greater income redistribution in Australia should reflect upon the fact that half of income tax is paid by 10 percent of taxpayers, and that nearly half of households pay zero net tax. On just how progressive our tax system already is, see this excellent fact check from my 1996 UQ economics honours classmate, ANU Associate Professor Ben Phillips:

FactCheck: is 50% of all income tax in Australia paid by 10% of the working population?

Ben is quoted in the latest Weekend Australian by Adam Creighton (Bill Shorten’s ‘left behinds’ actually got ahead) regarding some new analysis of household incomes he has undertaken:

Low-income households have ­enjoyed the biggest improvement in standard of living since the ­financial crisis, challenging Bill Shorten’s claim that inequality is rising and large parts of society are being “left behind”.

The bottom fifth of households ranked by income have had an 11 per cent rise in their living standards since 2007, more than twice as fast as those in the top income group, according to analysis ­undertaken at the Australian ­National University Centre for Social Research and Methods.

It appears we should be careful extrapolating US economic and social trends to Australia as is done in Fair Share.

I’m also sceptical about the secular stagnation thesis that the Fair Share authors advance as justification for fiscal stimulus. Australia’s unemployment rate is 5.5 percent and employment increased 3.3 percent in the 12 months to January. And, as the IMF has observed, economic growth is synchronised across the major economies internationally. Fair Share seems overly pessimistic to me.

So I mostly reject the policy recommendations of Fair Share, although I should note there is a lot of sound micro-economic and public policy analysis within the book that makes it well worth reading. Highlights for me included these comments:

  • Historically, Australia has likely over-invested in road transport and irrigation infrastructure, due to “the absence of market disciplines” (pp. 136-140); and
  • Australia spends enough on education and training already so “A big increase in funding is not needed; what is needed is a more equitable and cost-effective distribution of existing funding, especially for school education.” (p. 340)

Certainly we have made a mess of school funding in Australia. That said, we should move carefully as private schools save state governments a great deal of money, and we wouldn’t want to encourage a large decline in private school enrollments. On this point, see my 2016 post:

Excellent proposal for school funding reform from ISQ head David Robertson

In conclusion, Fair Share is a book worth reading, even though I disagree with its central thesis. The authors have done an excellent job in presenting the relevant economic and social data and discussing important policy issues, with the exception of immigration which is not considered, a major oversight given the intensity of the current debate. You can purchase a copy of Fair Share via Melbourne University Press’s website. Alternatively, you may be able to still find a copy at Dymocks on Albert St, Brisbane or at other good bookstores.

fairshare

Posted in Labour market, Macroeconomy, Uncategorized | Tagged , , , , , , | 4 Comments

Will 2018 be the year for Airbnb certainty in strata? Guest post by Stephen Thornton

Anyone living in an apartment block has probably noticed the increasing numbers of strangers with rolling suitcases who are obviously staying in Airbnb accommodation. Living in a Toowong apartment tower, I am frequently having to help short-term visitors find their way to Toowong Village. Hence I am delighted to publish this guest post from my friend and colleague Dr Stephen Thornton, Principal of BG Economics, on the increasingly important issue of Airbnb in strata. Views expressed are Stephen’s and should not necessarily be attributed to me. GT 

Will 2018 be the year for Airbnb certainty in strata?

by Dr Stephen Thornton

Queensland should finally be getting some significant changes to strata law this year, 4.5 years after the former Attorney-General Jarrod Bleijie announced that the QUT Commercial and Property Law Research Centre would undertake a property law review. To be fair, it is a big job. QUT have conducted the review in stages with a number of final recommendations reports having been completed and handed to the government.

However, one of the major contemporary policy issues in strata, how to respond to peer-to-peer short-term rental disruptors like Airbnb, was not part of the review. Having only been in operation for five years, the Californian company did not appear on the policy radar when the review was being considered.

I wrote about the benefits of providing a legislative green light to strata owners in this space last year (here) citing the Deloitte Access Economics report Economic Effects of Airbnb in Australia: Queensland in which they estimated that Airbnb guest expenditure is associated with $217.4 million in value add to the Queensland economy, and supports 2,115 FTE jobs across the state.

Just recently, MadeComfy, a short-term rental management company, used data from a commissioned 2017 study by economics and policy consultancy ACIL Allen and combined it with its own data. MadeComfy reportedly found short-term rental (STR) average weekly revenue outperformed the long-term rental (LTR) average in Sydney, Melbourne and Brisbane, with the Queensland capital registering an LTR average of $370 for apartments and $400 for houses versus a STR average of $447 for apartments and $720 for houses (Figure 1).

madecomfy

On the weekend, stakeholders in NSW attended a ‘Strata Matters’ forum to hear strata policy updates from Matt Kean, NSW Minister for Innovation and Better Regulation. On the agenda was the government’s Short-Term Holiday Letting (STHL) review and upcoming legislative response. According to Flat Chat apartment guru and Financial Review columnist Jimmy Thomson, the Minister advised that the government had not yet settled on a model and is still listening to all parties. Jimmy provides some takeaways from the forum here, one of which will also be relevant to Queensland:

The vast majority of people who like Airbnb and may have even used Airbnb don’t mind the letting of rooms in apartments when the owner or tenant is there (what Airbnb says it’s about) but really, really don’t want the commercial letting of whole apartments (by far the largest part of Airbnb’s business).

Anecdotally, I know that many apartment residents, particularly older folk, like the security of knowing who their neighbours are, even if some do turn over every six months (a typical lease period). Noise and other issues can be addressed over time, either informally by way of a quick chat or formally by notice of contravention of a by-law. Many may be less concerned if it were only a room being let every now and then with the permanent occupier being there. Indeed, some seniors benefit from letting a room, too, according to The Senior, with hosts aged 60-90 accounting for 16 per cent of all active hosts in the country, and a typical host income being $6,228 per year. Around 70 per cent of such hosts are women.

Like many economists, I am typically in favour of less regulation, not more. However, the state government will be required to introduce regulation in this space and there may be a case for restricting, but not banning, apartment owners in some buildings operating Airbnb and other similar services to mitigate some of the negative externalities I mentioned around security, noise and the like.

There are five regulation modules that sit within the Queensland Body Corporate and Community Management Act 1997, each of which have slightly different requirements in terms of how a body corporate may operate (see here for more information). Leaving aside the smaller ‘six packs’ and 2-lot schemes, the two residential modules for larger complexes are:

  • Standard Module—highly regulated, suitable for all schemes but especially where most owners live in their own lots.
  • Accommodation Module—less regulated, suitable for schemes where most owners let their lots.

A starting point for future discussion in regard to Airbnb and others might be around restricting residents to only letting out a room or rooms if the resident lives in the dwelling, too, in body corporate buildings subject to the Standard Module i.e. where most owners live in their own lots.

For residents living in strata schemes subject to the Accommodation Module i.e. where most owners let their lots, they would be free to let their entire apartment with Airbnb in addition to just a room if they so wish. I use the term ‘resident’ to mean both the owner and the tenant, although in the case of tenants the owner’s permission would be required to undertake such activities and, indeed, would likely be subject to the terms of individual leases and, therefore, subject to the relevant residential tenancies legislation.

We already have some product differentiation operating in strata schemes in Queensland, as determined in the different regulation modules discussed. Using this module framework to incorporate particular Airbnb rules would not only be a relatively simple task but it would (or should) be easier to understand. In this way, policy certainty could be achieved within the existing regulatory framework, with some amendment undertaken after full examination and consultation.

Dr. Stephen Thornton is a social economist and principal of BG Economics. Disclosure: Stephen owns a strata investment property in Brisbane.

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City of Brisbane Investment Corporation’s peculiar investment philosophy

I have previously been critical of the City of Brisbane Investment Corporation (CBIC), which is owned by the Brisbane City Council, but is becoming a significant property investor and developer, raising all sorts of questions about the risk it is exposing ratepayers to, the appropriate role for Councils in the economy, as well as potential probity risks  (see this November 2014 post). Recently, the ALP’s unsuccessful 2016 Lord Mayoral candidate, Rod Harding, has asked similar questions about CBIC, including in this Courier-Mail opinion piece: Property speculation by Brisbane council a ‘risky’ use of ratepayer money.

It would surprise many Brisbane ratepayers that the Council, through CBIC’s subsidiary BrisDev Pty Ltd, is developing a 90-unit apartment complex at Toowong: Augustus Residences at 24-26 Augustus St (see this Brisbane Times report). With a huge supply of units already coming on to the market in Brisbane, this is a fine time for Council to get in on the action.

Certainly one wonders about the quality of investment decision making at CBIC. The 2017 Annual Report for the CBIC reveals property represents the largest share of total assets by value, but there is also a peculiarly high allocation of assets to low-yielding cash investments (i.e. investments in the short-term money market which earned CBIC a 2.5% return in 2016-17), and no apparent allocation to equities (Chart 1).

Chart1_CBIC

Contrast CBIC’s peculiar investment allocation with that of the highly diversified Australian Future Fund (Chart 2). The comparison is relevant because Brisbane Lord Mayor Graham Quirk has described CBIC as the city’s future fund. But a true future fund would be much more diversified, optimising the risk-return trade off, and avoiding such a heavy concentration in high risk property investment.

Chart2_FutureFund

CBIC earned a return of 11.3% on its property investments and an overall 8.5% return in 2016-17. While this seems impressive, consider that the Australian Future Fund earns a similar rate of return, but with a much more diversified and less risky portfolio (see the Future Fund Portfolio Update).  Over the last ten years, the Future Fund has earned an annual return of 8.1% p.a. on average and in 2017 it earned an 8.8% return.

Also, consider that part of the CBIC’s property investment return may be illusory, due to its close relationship with Council. It appears to be getting preferential access to properties owned by the Council, and it is also benefiting from leasing out space to the Council at many of its investment properties. The CBIC’s 2017 Annual Report, which I obtained a copy of thanks to the Council Opposition’s office, notes on p. 24:

CBIC has the ability to access surplus property assets within Council’s portfolio, which has enabled CBIC to maximise returns through development and further investment in these assets.

This statement makes me suspect that CBIC is obtaining Council properties at very favourable prices, and much more favourable than prices private developers would have to pay. So part of the return it earns could simply be a transfer of value from the Council to CBIC, as the Council has denied itself the higher prices that private developers may have paid, and CBIC benefits from having secured the properties at very favourable prices.

Looking at the income statement of CBIC, I see that a large share of its income comes from unrealised (fair value) capital gains on property assets (Table 1). So a large share of the $20 million dividend BCIC pays to Council is associated with unrealised capital gains, which to an extent may derive from the dubious process I have just speculated upon. That is, the dividend may be illusory, in part, as the Council is just getting back money it lost by not selling the properties at appropriate prices in the first place. I should also note companies should be cautious paying dividends out based on unrealised capital gains, which may not ultimately materialise.

Table 1. CBIC income statements

  2017 ($M) 2016 ($M)
Income    
Rental income 11.0 8.3
Interest 5.3 3.5
Distribution income 0.4 0.3
Fair value gains on property assets 8.6 14.0
Gain on sale of investments 3.9 0.0
Other income 0.3 0.2
Total income 29.4 26.3
Expenses    
General and admin. expenses 1.7 1.9
Remuneration costs 1.4 1.1
Building expenditure 2.8 3.4
Loss on disposal of financial asset 0.0 5.2
Total expenses 5.9 11.7
Fair value gain/(loss) on equity investments (unrealised) -0.5 -0.9
De-recognition of available for sale financial asset   5.2
Total comprehensive income (i.e. profit) 23.0 18.9

Source: CBIC 2017 Annual Report, p. 8.

In summary, CBIC, while still relatively small in the greater scheme of things, is creating unnecessary financial risks for BCC ratepayers by taking on property developments that should instead be undertaken by the private sector. A review of CBIC’s investments—and CBIC’s very reason for being—by independent experts is urgently required.

N.B. I would upload the CBIC’s Annual Report to my site if it weren’t such a huge file. Please get in touch with me if you’d really like a copy of it and I’ll see how I can get it to you.

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On Qld’s relative lack of big private sector employers

Business registrations data published by the ABS reveal Queensland has disproportionately fewer major private sector employers (with 200+ employees) than southern states. And the gap is particularly disproportionate in several sectors, including information media & telecommunications, professional, scientific & technical services, financial & insurance services, and retail & wholesale trade (see chart below). Overall, Queensland has around 610 businesses with 200+ employees, compared with over 1,500 in NSW and nearly 1,100 in Victoria. This disparity is much larger than can be explained by relative sizes of the economies: NSW’s economy is only around 75 percent larger and Victoria’s economy is only around 25 percent larger than Queensland’s.

Big businesses figure 1

Looking more closely at some specific industry sectors (see Charts on businesses with 200+ employees for selected industries), such as professional, scientific & technical services, I am disappointed Queensland appears to be massively under-performing across a range of sub-industries, including in one consistent with the aspirations of a Smart State, computer system design & related services.

Obviously, path dependence partly explains Queensland’s relative lack of major private sector employers. Many of Australia’s largest companies were originally established in southern states and Queensland historically was much less significant in the national economy than it is today. But the figures should be concerning to Queensland Government officials, nonetheless. To me, they suggest the need to stop wasting precious resources on luring craft breweries or Hollywood movie productions to Queensland. The state government should instead focus on keeping business regulation and taxes to a minimum, improving our education and training system, and inspiring more Queenslanders to become entrepreneurs.

For other analysis of the business counts data, see Nick Behrens’s latest post:

The Health of the Queensland Business Community (The Good and the Bad)

For my views on industry policy measures to be avoided see:

Ragnarok in Brissywood

Comments on BrewDog being lured to Brisbane in the Broadsheet

N.B. For clarity, the data above relate to where businesses are registered. Many large businesses registered in NSW and Victoria will have employees in Queensland, but their head offices are likely to be in Sydney and Melbourne.

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Should Australia cut the company tax rate?

Pauline Hanson’s opinion piece in yesterday’s Australian arguing against the Turnbull Government’s planned company tax cut (and in favour of state government payroll tax cuts instead) may well mean the end for the Turnbull Government’s planned cut. Hanson’s article highlights the impact of dividend imputation, which is designed to avoid the double taxation of corporate income (i.e. taxing company profits and then taxing dividends to shareholders) which occurs in many countries such as the US. As Nicholas Gruen explained in an insightful 2006 CEDA paper Tax Cuts to Compete (p. 17):

Because imputation means that company tax operates as a withholding tax against Australian shareholders’ personal tax liabilities, company tax itself has little distributional significance.

That is, dividend imputation means that the benefit of a company tax cut would be offset to a large extent for domestic shareholders. Dividends may increase, but shareholders would receive fewer franking credits (relative to what they would have at a higher company tax rate) to reduce their personal tax liability. Foreign investors didn’t receive any benefit from Australian franking credits in their own jurisdictions anyway, so logically foreign investors would receive most of the immediate benefit of any company income tax cut. That said, domestic investors receive some short-term benefit due to improved company valuations (as the company tax cut allows greater retained earnings) and the fact capital gains are taxed at a concessional rate.

In the long-run, domestic and foreign investors as well as workers are expected to benefit from a company tax cut, as a lower cost of capital associated with a lower company tax rate leads to an increase in capital investment and higher labour productivity. This may take several years, possibly up to a decade, to have a noticeable impact. The best and most convincing analysis I have seen regarding the potential impacts of a company income tax cut was written by University of Melbourne Economics Professor John Freebairn and published in the Australian Economic Review in 2015: Who pays the Australian Corporate Income Tax? Freebairn’s analysis should be compulsory reading for anyone wishing to comment in the company tax debate. Regarding a company income tax cut, Freebairn notes (on p. 357):

In the short run, non-resident investors are large winners at the expense of government revenue. In the long run, some of the short-term benefits to shareholders are eroded, one-half or more of the benefits goes to higher wages and about one-third of the first-round loss of government revenue is recaptured.

Freebairn acknowledges the magnitudes of the benefits of a company income tax cut depend on the extent to which capital is mobile between Australia and other economies, and this is uncertain. So he provided a range of estimates based on various assumptions about capital mobility which all tend to show large shares of the benefits of company tax cuts going to workers, while foreign shareholders receive a greater share of the benefits than domestic shareholders, in the long-run (see figure below). Freebairn’s estimates show that 30-35 percent of the revenue forgone by the company tax cut comes back to government via income tax and other taxes.

Freebairn_estimates

The fact that it is expected only a small proportion of the benefits of a company tax cut accrue to domestic investors (and no benefit accrues to labour in the short-run) goes a long way to explaining why the Turnbull Government has found it so difficult to promote its company tax plan. That said, there is little doubt there would be long-run economic benefits from a company tax cut, provided the Government can keep its budget under control and rein in public debt. Of course, I acknowledge a company income tax cut would make this more difficult, particularly given the “starve the beast” hypothesis (i.e. tax cuts compel later spending cuts) doesn’t have much empirical support. From a budget management perspective, the proposed company tax cut is concerning, so the Turnbull Government needs to be very confident it will provide the large economic benefits it is expecting.

While the exact magnitudes of the impacts of the company tax cut would be uncertain, I don’t think the fact that positive economic impacts exist should be controversial. The ABC’s Emma Alberici was rightly criticised for her recent opinion piece, which didn’t fairly reflect the large amount of high quality analysis by the federal Treasury, Chris Murphy and other economists that has already be done on the impacts of a company tax cut.

For example, see Chris Murphy’s study The effects on consumer welfare of a corporate tax cut in which Murphy estimates long-run gains to GDP of 0.7-0.9 percent and in the real wage of up to 1 percent. And consider that Murphy’s modelling doesn’t take into account the impact of the Trump tax cut, which is undeniably another reason Australia should consider cutting company tax. Incidentally, Murphy (on p. 23) effectively counters the finding made in a Victoria University study that a company tax cut could decrease gross national income (even though it boosts GDP) by noting some of its model parameters appear odd and it did not correctly model the impact of dividend imputation.

Based on the analysis by Murphy, Freebairn and others, I disagree with Professor Fabrizio Carmignani from Griffith University, who has recently written a Conversation piece titled There isn’t solid research or theory to support cutting corporate taxes to boost wages. Unfortunately, Fabrizio has ignored the economic modelling of a company income tax cut conducted by leading economists such as Chris Murphy and John Freebairn.

Finally, I should acknowledge that, in the CEDA paper by Nicholas Gruen I referred to above, Nicholas argued in favour of abolishing dividend imputation entirely and cutting the company tax rate to below 20 percent. This would certainly lower the cost of capital and boost investment much more than the Turnbull Government’s proposed cut, but I have reservations about it. It would introduce a bias in favour of debt finance, as Nicholas acknowledges in his paper (p. 23), and it would imply an increase in the taxation of dividends paid to many Australian shareholders. Nonetheless, given the apparent failure of the Government’s current plan to cut company tax, Nicholas’s plan is certainly one that should be assessed among alternative options.

Posted in Tax, Uncategorized | Tagged , , , , , , , , | 5 Comments