Tag Archives: tax

Gibbons and welfare

Regular contributor James Glover, aka Zebra, returns in a post that manages to combine gibbons, tax and a beer coaster.

A question I often ask myself is how could gibbons possibly develop a civilisation comparable to our own? Gibbons are solitary creatures so do not form troops, groups or tribes. Developing and passing on knowledge in a gibbon society is therefore a long and chancey game. I imagine the gibbon equivalent of an Einstein stumbling upon a rock scratched by a long-dead gibbon Newton and after much pondering leaving his own scratchings to be found by some future generation’s gibbon Hawking. Actually, they are more likely to be the gibbon equivalent of Marie and Pierre Curie since gibbons pair-bond for life. They live in large open ranges well away from other gibbons. That loud “woop-woop-woop” you hear in zoos is the gibbon call for “get ‘orf my land”. It seems though that, bar an unlikely series of genius offspring, gibbons will never develop the tools and technology that could one day put a gibbon on the moon. And it seems equally unlikely that gibbons will ever develop a system of mutually supportative taxation either.

My point here is that income tax, and indeed all tax, is inextricably tied to the social nature of our species. To even conceptualise that there are many to take from and some to give back to requires more than two fruit/income-sharing individuals. Many people argue that taxes represent a crushing of the individualistic spirit of our species. I would rather say that it’s a celebration of our social nature.

There is a vocal minority which claims that there is nothing which taxes provide that could not be more efficiently provided by private enterprise, including the sine qua non of socialist governments, welfare. And they appear to have been proved to be right in the last few decades, which saw the privatisation of parts of government that were once thought to be unprivatisable, including national banks, utilities and prisons.

Yet we live in a society in which many people, while opposed to the specific taxing of the underprivileged (i.e. “me”), are happy to receive the benefits of taxation. There are, in my opinion, two types of taxation benefits. Firstly those which we are all equally able, at least in theory, to enjoy such as roads, schools and defence. And then those which are “targeted towards the needy”, as the phrase goes. As the genuinely needy diminish in numbers, the number receiving what is now called “middle class welfare” increases.

CoingsIn the recent furore over middle-class welfare it is frequently (but wrongly) stated that there is no point in child care payments to the middle classes. It is argued that since it is they who pay the majority of income tax (their greater numbers mean their tax payments are more in aggregate than those of the highest income earners) then the money just goes around in circles pointlessly. In fact there are very good reasons for making these child care payments. Even if everyone in society paid precisely the same amount in income tax and had exactly 2 children, to tax all and pay some is effectively taxing our younger and older years when we don’t have children to support. This tax is then reallocated to our middle years to subsidise the increased costs of raising children before they leave home. That doesn’t seem like such an outrageous idea and presumably is the basis behind the reasoning of those allegedly loony socialists, the Scandinavians, who pay generous child care support to all but the very wealthy.

This does not mean that in our society, where income inequalities do exist, that everyone should receive child benefit. There are clearly people who are very well off and do not need to be subsidised by their younger or older selves so it is inefficient to do so. It just means that the income cutoff is higher for child benefit than for other forms of welfare.

In Australia in the debate about middle-class welfare, which has been spurred on by the recent budget, the battle line has been drawn at a household income of $150,000 a year. An editorial in The Sunday Age (May 1 2011) made the claim that welfare in Australia was well-targeted because the top 40% of households only received 4.6% of the welfare budget. So I decided to run the beer coaster over some numbers. With the help of Google, I estimate a total welfare budget of $110 billion. This is made up of $60 billion in unemployment benefits (600,000 unemployed at about $10,000 per year on Jobstart) and $20 billion on the Disability Support Pension which pays about double the dole but requires more stringent eligibility tests. On top of this, about $30 billion is paid on child care and family benefits. Taking 4.6% of this $110 billion gives about $5 billion per year. Enough to build a couple of new hospitals and several schools and staff them with 5,000 teachers and nurses. Or indeed enough to invade a medium sized Middle-Eastern country. If you use my usual back-of-the-beer-coaster figure of 8 million households in Australia, then that is about $1,600 for the top 40% or highest income 3 million households. I can’t think what they need to spend it on. Although, as I noted in a letter to The Sunday Age in response to their editorial, this figure is coincidentally about the cost of a premium family subscription to Foxtel.

Gibbons also have children and the way they get them to leave the home patch of jungle is to ignore them more and more and then eventually treat them like strangers and shout at them to go away. This is the reverse of the process followed by humans, whereby the maturing children ignore their parents and then shout at them to go away before abruptly leaving home. I believe it is in our solitary versus social natures that an explanation lies for why the approaches of gibbons and humans to both child-rearing and taxation differ so much.

Is this the stupidest provision of the U.S. Tax Code?

Two guest posts in one week! On this occasion, the Mule is yielding the soapbox to an anonymous and unqualified cynic who wants to talk about tax (his own words).

House and diceDecline in housing affordability relentless“. So screams the Real Estate Institute of Australia in its latest Deposit Power Housing Affordability Report, and they’re not the only ones. Of course, what they’re really screaming about is the (in)ability of people to purchase their own home – private renters, constituting a mere 25% of households, or social housing tenants at a mere 5%, only very rarely rate a mention. Why? The answer, in part, lies in just how beneficial it is to be part of that home-owning majority. The Australian tax system provides many advantages to the home-owner. The holy trinity of exemptions, in order of their estimated value in 2005-06 Australian dollars, are shown in the table below.

Tax Exemption Value
Land tax Owner occupiers are exempt from state-based land taxes $3.5 billion
Tax on imputed rent* Imputed rent is not taxed, nor is it captured by GST $11.7 billion
Capital gains tax Owner occupiers are exempt $29.8 billion
Table 1: Tax concessions to homeowners

These benefits are designed to encourage home ownership, which is seen as a social good. This argument is typically justified either on cultural grounds (the importance of home ownership to our society, or the centrality of home ownership to the “Australian Dream”) or occasionally on economic grounds, in that home ownership is said to produce positive externalities (for example, children of homeowners may have a higher likelihood of finishing school, or a lower likelihood of criminal behaviour). However, others argue that any social good which is intended by these benefits is undermined by the fact that the concessions are distributed inequitably, with high income households receiving a much greater advantage than low income households. In particular, the capital gains tax exemptions are worth seven times as much to the top income quintile as they are to households in the lowest income quintile. But Australians concerned about efficiency and equity in the tax system might take some heart from the fact that the grand-daddy of all tax concession to homeowners is missing from Table 1: home mortgage interest deduction.

In the United States, mortgage interest repayments are fully tax deductible on up to two homes, capped to a debt level of $1 million. Historically, this deduction was available across all interest repayments. Rising levels of household debt in the United States throughout the 1970s, associated with the rising popularity of credit cards, led to a rethink of the wisdom of interest deductibility. However, the deductibility of housing mortgages remained, ostensibly to facilitate ever increasing rates of home ownership, but perhaps more honestly as a nod to the middle class who had come to think of this deductibility provision as a birthright, as the keystone to the “American Dream” (a dream which is eerily similar, it seems, to the aforementioned Australian Dream). While it is true that home ownership rates in the United States have increased over the past fifty years, it is not clear that this is as a result of this particular tax benefit. Indeed, home ownership rates in the United States are comparable to those in Australia, which has no such concession (although both countries offer similar capital gains exemptions).**

Country 1961 1990 2007-08
Australia 70% 69% 68%
United States 62% 64% 68%
Table 2: Home ownership rates

Many argue that home ownership rates have increased far more substantially as a result of financial innovation and the deregulation of the mortgage industry – although, of course, the net benefits of these innovations are still being debated. In fact, many economists argue that, far from enfranchising aspiring homeowners, tax deductibility of interest is a regressive policy measure which affords a much more substantial benefit to the wealthy than the poor. There are three main reasons for this.

Firstly, the size of the concession is obviously related to the size of the mortgage, and as such wealthier households accrue a greater benefit, in absolute terms. Secondly, the deduction is more valuable to taxpayers in the highest income tax band. Thirdly, the deduction can only be claimed if an itemised tax return is submitted. However, lower income households overwhelmingly fill out a so-called standard deduction, not an itemised one. In fact, while 98% of households with incomes above $125,000 itemise, the figure is only 24% for households with incomes below $40,000, and therefore the remaining 76% would not be eligible to receive the benefit. One model estimates that in 2009, 68% of the total tax change associated with mortgage interest deductions went to the top income quintile, while nearly 90% of the total tax change went to the top two income quintiles.

Even more economists argue most against the mortgage interest deductibility provision on the grounds of its being so expensive. The 2010 United States Federal Budget calculates the cost of the mortgage interest deduction at US$131.2 billion. By comparison, the next largest housing tax expenditure was attributed to capital gains exemptions, which came in at US$49.6 billion. Another potential side effect of this concession is to encourage leveraging at the household level. In its latest Economic Survey of the United States, the OECD argues that increased preponderance of interest-only mortgages was a symptom (if not a cause) of the housing crisis. Interest only mortgages are particularly attractive in terms of the mortgage deductibility, as it makes repayments deductible in their entirety.

The Bush administration convened an expert panel to develop tax reforms, one of which was a proposal to change the home mortgage deduction to a 15 percent credit and making it available to all filers, regardless of itemization status. This was immediately rejected out of hand. The Obama administration more recently suggested that home mortgage interest deductions would be capped at 28%. However, commentary on this proposal suggests it has failed, although everyone appears more  focused on the politics of such a measure, not the economics.

It seems that this is yet another example of “Murphy’s Law of Economics” – the overwhelming weight of expert opinion is no match for the American Dream. Must we, then, accept that this is an instance of the truism of tax concessions, which is all too apt when one is talking about the family home: that they are easy to introduce, and near impossible to repeal?

* A renter has to pay rent from income that is taxed, but the homeowner does not. It can be argued that the homeowner effectively earns an income from their property, in that they pay an “imputed rent” – to themselves. This effective income is not taxed, although some would argue that it should be.

** A limited home mortgage deductibility scheme was part of Gough Whitlam’s “It’s Time” package. It was designed as a response to rising interest rates, and was specifically targeted at the lower end of the income scale. As he said in his 1974 policy speech: “All taxpayers whose actual income is $4,000 or below will be entitled to deduct 100% of their interest rate payments. The percentage of total interest payments which is deductible will be reduced by 1% for every $100 of income in excess of $4,000.”

Data Sources: J. Yates, Tax expenditures and housing, AHURI, September 2009; U.S. Census data; Australian Census of Population and Housing

Photo credit: Copyright creative commons by woodleywonderworks

RSPT RIP – Long Live the MRRT

In the third in a series of guest posts on the subject of Australian mining tax, Zebra (James Glover) considers the changes to the proposed tax the new prime minister, Julia Gillard, has negotiated with miners.

The Govt has announced a replacement for the RSPT discussed in earlier posts to a Mineral Resources Rent Tax (MRRT). The principle differences are the tax rate – 30% and a change in the deduction. For established mines it is now based on market value depreciated over 25 years and the uplift rate is 12% not 5%. In addition there is a 25% deduction from earnings upfront which makes the base rate of tax 22.5% rather than 40%.

This post replaces an earlier one I put up about the MRRT in which I erroneously assumed that the opt-in about using the market value of assets applied in the way I proposed in my second post. The key statement here is:

“Miners may elect to use the book or market value as the starting base for project assets, with depreciation accelerated over 5 years when book value, excluding mining rights, is used; or effective life (up to 25 years) when market value at 1 May 2010, including mining rights, is used. All post 1 May 2010 capital expenditure will be added to the starting base.”

In the case where the mining company opts to use a market value approach I take it to mean the depreciation takes place before the MRRT is calculated. This means the formula is:

MRRT = 30% x (75% x Earnings – Price(2010)/25)

Currently the mining industry average for P/E (price to earnings ratio) is 14, though in the case of BHP-Billiton it is 19. For an average miner then Price(2010)/25 = Earnings x 14/25 = 56% Earnings so the actual MRRT is based on 19% of Earnings. However the Price is fixed at the May 1 2010 value so this will not increase over time even though earnings will. Should earnings continue to rise at the dramatic rate we have seen in the past decade then the MRRT will eventually look more like the 22.5% base rate.

It appears that the Govt and the mining industry’s compromise is to push the revenue from the tax windfall out from today to later years. In a sense the mining industry has also removed the contentious “retrospectivity” of the tax by using the current high price and choice of 25 years depreciation to ensure the current value of the MRRT is minimised but will rise at 22.5% of increased earnings going forward.

Thanks to an observant reader who pointed out my error. Mea culpa.

The Australian Resources Tax

The recent announcement by the Australian Treasurer of plans to introduce a “Resource Super Profits Tax” (RSPT) has led to the longest discussion thread on the Mule Stable yet. A lot of the discussion turned on whether or not share investors can be considered to have lost anything when share prices fall if they have not sold their shares.

Whether or not “unrealised losses” should be considered real losses takes us back to an oft-visited topic: the nature of money. Money has many guises: store of wealth, medium of exchange and, most relevant here, unit of value. Finance has its jargon like any other discipline and when money serves as a unit of value, it is known as a numéraire. Today, however, I will not explore the theory of money any further (although, you can trawl through the Mule Stable discussion to gather some of my thoughts). Instead, I will focus on what has happened to mining stocks.

The chart below shows the performance of the S&P/ASX 300 share price and the Metals and Mining index. While not quite as broad as the All Ordinaries index, the Australian stock market is dominated by large companies and in fact the market capitalization* of the ASX 300 is around 85% of the All Ordinaries, so it does give a very good indication of the performance of the overall market. The Metals and Mining index simply consists of those companies in the ASX 300 that are categorised as being (no surprise) in the business of metals or mining. In order to provide a direct comparison, both of these indices have been scaled to a common base of 100 on 30 April. This was this the Friday before the weekend announcement of the RSPT.
Performance of resources since RSPT announcement

Performance of the Mining Sector following the RSPT announcement*

As the chart clearly shows, the metals and mining index certainly did suffer more than the market as a whole in the first couple of days after the announcement. By the end of Tuesday, resources had fallen 4% more than the ASX 300.  Since the RSPT can only serve to decrease not increase profits of resources companies, this fall would seem quite reasonable. Curiously though, this week resources closed the gap once more. In fact, the resources sector has now performed 0.35% better than the overall market!

Of course, one could argue that the sector returns would have been even better over the last two weeks if the tax had never been announced. That may well be the case, but it is hard to argue that the Government had caused a terrible mischief to the superannuation savings of all working Australians when resource have, well, matched the performance of the broader market.

*Data source: Standard and Poor’s