If it’s a good policy it doesn’t need exemptions.

My instincts already lead me to distrust anything that Bill Shorten says. Recently he found a way, in the name of fairness, to save $65 billion dollars in the budget by not paying franking credits to people with low ‘taxable’ income. His policy was targetted at the Liberal heartland of older self-funded retirees. Then someone pointed out that this policy would hurt poorer people as well so he back-tracked and said, of course,  genuine pensioners would be exempt. But then an ordinary working person with a low income and some shares might also be affected. What then? Another exemption?

The lesson to learn is that making policies on the basis of political considerations is always going to lead to inconsistencies, and then making exemptions creates more inconsistencies.

Good policies don’t require exemptions. Exemptions create opportunities for people to adjust their behaviour to take advantage of the new loophole. Costello created the problem back 11 to 13 years ago. He first exempted drawing from a retirement fund from income tax. That was reasonable, as such drawings are like taking money from your bank account. But he also made earnings within a retirement fund free from tax. Contributions to super funds were already concessional. At first, the cost to the budget was minimal, but now it is huge and growing. While superannuation rules were originally created to encourage ordinary Australians to contribute to their own retirement, Costello created a virtual tax haven on-shore that mainly advantaged the already wealthy.

Super concessions were initially there to compensate those who were not drawing a pension, but we now had the case where the tax concessions far exceeded the value of universal pensions. The current government has already put in train some changes which will, over time, dilute the worst excesses of Costello’s policies. These same policies will also negate the effect of Shorten’s thought bubble.

There should be some simple rules that can be applied to see if a budget measure is a good one.

  • Does the measure encourage an undesirable change in people’s behaviour?
  • Does the measure apply to citizens in an equitable manner or in a regressive manner?
  • Does the measure discourage self-reliance and invite people to become welfare dependent?
  • Is the measure so complex that an ordinary person requires a planner to assist them, even though they probably don’t realise it?

Here are some examples of what I mean.

I saw a chart of incomes reported to the Tax department and many of them were clustered just below the marginal tax thresholds, like $87,000. This was very sad because it meant these people didn’t understand marginal tax rates. They had forgone income they could have earned and enjoyed because they thought that by earning over $87,000 they would pay a lot more tax.

The baby bonus was a bad policy because some naive poor women had children just to get a small bit of cash.

People will delay or sabotage their recovery from illness or injury in order to gain a disability allowance. The reason for this is that unemployment benefits are so miserly and difficult to qualify for.

Asset tests on pensions are bad policy (in their current form) because the exemption for the family home and the rules about gifts make it impractical for some pensioners to sell their large home for a smaller one.  Likewise, farmers who want to stay on their farm (their home) after they retire will be penalised because of a rule about property size.

Let’s ask a few questions that might point us to good tax or pension policy.

  • Who should get a bigger pension? A person with a $3million home or a person with just $100,000 in the bank? (I think they get about the same.)
  • Who pays more tax? A 25 year-old person with a $1million home, $0.5million in super and income of $80,000 or a 55 year-old with the same income but no assets? (It’s the same, except that the super fund will pay a little tax.)
  • Who should get more income assistance? An unemployed couple with two teenage children or a single teenage girl with one child under five living with her mum? (I’m pretty sure that the single parent gets a lot more.)
  • If a man put his home into a trust many years ago but then died and the proceeds of the trust passed to his spouse, what would be the tax consequences? I think his wife will have a huge CGT bill to pay.

I often read Noel Whittaker’s column in the Herald. Apart from constantly reminding me how poor I am, it amazes me what a minefield awaits unwary people when they make decisions about their wealth, getting pensions, saving on CGT etc. In most cases Noel can only tell people the rough chances of their plans blowing up in their faces and suggest that they get professional advice. It’s as if the gnomes who populate the bureaucracy are constantly manipulating the rules to trap the poor fools who haven’t done their homework.

So I conclude that the current system is both complex and unfair, littered with inconsistencies and loopholes that punish the naive and reward the cunning.

My view is that simplicity is key to fairness and that exemptions may seem to be justified in some cases but we should always think whether there is another way to achieve the same end. I’ll give my plan in a future blog.

 

 

 

 

 

 

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Why we have the current house price crisis.

We need to explain why house prices have risen throughout Australia and why Sydney and Melbourne house prices seem to be out of control.

Interest rates

The main influence is interest rates. People will pay what they can afford. As interest rates have consistently gone down house prices have gone up. However, even though the home buyer can afford to repay larger loans with lower interest, the size of the required deposit rises out of proportion and the consistent growth in home prices has meant getting a deposit is blocking out many new home buyers.

Demographic change

The second influence is population growth. With a static population house prices would settle at some fixed standard and would move pretty much in fixed ratio with incomes. With population growth comes competition for the existing stock of houses. Not only is the population of Sydney and Melbourne rising but there is a change in the demographic. Home ownership is important to new immigrants from Asia, and not just one home but several. Some young immigrants from China came here as the children of wealthy Chinese. They have resources behind them and a desire to have the best. They also have resources to overcome the deposit gap.

Tax 

Negative gearing and CGT concessions are a strong signal to these buyers. Even if these will not actually make a person richer, the existence of these sanctioned tax avoidance mechanisms is attracting people to make certain investment decisions, even to make bad ones. For people who see homes as a store of wealth these are special incentives. Again, this goes to the special nature of the current home-buying demographic. As prices have continued to rise the investment decision is proven to be correct and entices another round of bidding up.

Overseas buyers

Overseas buyers may only be ten percent of total new home sales, especially apartments, but as many of these are remaining vacant, this investment is actually diverting resources from adding to the supply. Sydney and Melbourne are stand-outs because of their stature as ‘World Cities.’ The attraction of having an asset in such a city at a time when prices are rising at much higher rates than other investments can be a status thing for overseas buyers. Given the populations of countries involved dwarf the Australian population of home buyers there is likely to be some pressure on housing for some time.

The bubble

Is there a bubble? There appears to be a bubble in Sydney and possibly in Melbourne. Will it burst? If interest rates rose to what they were twenty years ago prices would have to come down but that is unlikely. It would cause such a recession that interest rates would drop back to even lower levels. It’s likely that the principal factors at play continue for some time. Overseas buyers will continue to try to buy property in Sydney and Melbourne. Those who have amassed wealth through tax-incentivised investment will continue to do so.

The oft-stated proposition that houses are ‘unaffordable’ is nonsense, as someone can afford them, or thinks they can. The statement that the problem is a lack of supply is partly nonsense because it cannot be used as a basis for policy. The number of homes within 10 kilometres of the city or with a harbour view or on a decent-sized block of land is fixed. So, what can be done?

Here are some policies that would work:

  • Reduce population growth
  • Remove the dual incentives for investing in houses as the only way to amass wealth – either CGT concessions or negative gearing has to go.
  • Increase taxes on unoccupied dwellings to remove incentives to buy property just for the capital gain.

Some policies that would not work:

  • Allow people to access superannuation to get a deposit
  • Increasing first homebuyer grants
  • Any policy at all that is aimed at the demand side