Wednesday, January 18, 2006

No tax but they're not happy, Pete

Imagine that you were able to (legally) pay no income tax. You'd feel pretty happy, right? Apparently not. This year an astonishing 38 per cent of Australian families will pay nothing to the Government in net terms, and there's plenty of evidence to suggest they're anything but happy.

Let me explain what I mean by no tax "in net terms". Those families will, of course, have tax collected from their pay packets through the PAYE system in the same way most of us do, but they will get all of that money back and more in the form of Commonwealth Government payments - in particular the family tax benefit and the new child-care tax rebate. The income levels at which this can happen are quite extraordinary.

Labor's Senator Chris Evans has had the Parliamentary Library do the calculations for a family on a single income with one child in school and another in child care for 20 hours a week. As reported in The Australian Financial Review, from the middle of this year when the new tax cuts come into effect, such a family could earn more than $53,000 and still pay no net income tax.

(The family will, of course, pay GST, which is formally a state tax, and a number of other government charges.)

Naturally it is an offer only available to Australians with children. A childless couple on the same money would pay $13,000 in tax. The position for such couples has actually worsened in recent years as cost-of-living pay rises have pushed more of their income into higher tax brackets.

But are these childless Australians on average incomes who actually pay tax about to be rewarded? It seems not. The Treasurer, Peter Costello, has promised that the upcoming budget will focus once again on families; in his words: "the people that need help in contributing the greatest gift to the future of our society - children".

Why should they need even more help? It could be because of the extraordinarily ham fisted way in which the help to date has been delivered...

Obtaining the family tax benefit, worth $10,000 a year to many parents, has become an exercise in humiliation. New parents whose financial circumstances are in the process of changing are asked to estimate their likely income one year in advance.

Millions get it wrong and are hounded like cheats. First there are polite letters comparing their actual income with their estimate and asking that some of the benefit be repaid. Then there are urgent letters demanding that the parents phone the "recovery staff" straight away. Then high-pressure sales techniques from the recovery staff along the lines of "don't tell anyone I told you this, but just for you I can start the repayments at the low rate of" and "this offer is only available today. If you ring back tomorrow you will be dealing with someone else and will have to go back to scratch."

And then there are letters from Dunn & Bradstreet collection services threatening unspecified action unless the debt is immediately settled.

There is no doubt that the Government knows that it has antagonised the people it is trying to help. It tried to paper over the problem with an extra $600 payment just before the last election.

But it didn't learn from its mistake. The new child-care tax rebate announced during the election campaign is in some ways even worse. In the words of the Coalition's Jackie Kelly, it appears to be "designed by people who don't use it".

If your child is in care during this financial year you are meant to hang on to your receipts. But the Tax Office says you won't be able to use them to claim the rebate until the end of the following tax year, half way through 2007.

This means that many parents won't get the money when they actually need it, while their child is in care.

Instead they will get it later, when their child has left child care to go to school. Research conducted for last year's Child Support Task Force found that the cost of caring for a child halves as a result of the transition to school.

Someone in the Government has designed a system that withholds money from parents at time when their expenses are high and gives it back when their expenses are lower.

On Sunday in Los Angeles an apparently oblivious Peter Costello defended the system saying he expected the fuss to die down. "I think once they do claim that 30 per cent rebate, that's going to make a lot of difference to the cost of child care."

Poor design appears not to worry the Government in another area of financial policy as well. An estimated 5 million superannuation accounts are "lost" - they have been dormant for years and the mail addressed to their owners is marked "return to sender".

Last week the Labor Party put forward a plan to trace the owners of the lost money using tax file numbers.

The Assistant Treasurer, Mal Brough, rejected the plan, saying: "This Government prefers to encourage Australians to take a strong interest in their retirement savings, rather than seeking to disengage Australians by making important decisions on their behalf."

It is as if our Government is trying to make life difficult for us, even in the midst of generosity.

More than 300 years ago a French minister for finance, Jean-Baptiste Colbert, defined taxation as the art of "so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing". Whether through incompetence or indifference, the Australian Government seems to have designed things so as to maximise the hissing. Even when it is giving money back.

It is little wonder that even those Australians who pay nothing whatsoever to the Federal Government are upset.

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Wednesday, January 11, 2006

Fix your rate: it is money for Nothing

In the famous joke about two economists out for a walk one asks: "Is that a $20 note I see lying on the footpath?" The other replies: "Couldn't be. If it was someone would have picked it up by now."

It's actually a useful mindset to have. The truth is that most of the times we are offered a chance to make (or save) money without effort there is a catch. Mark Knopfler's legendry hit Money for Nothing was ironic.

But those of us with that economist's mindset also miss out on the much rarer, absolutely genuine opportunities to get money for nothing that do exist, sometimes right under our noses.

One of them is available right now, under the noses of Australians with mortgages. It isn't $20 on the footpath; it is the opportunity to save literally tens of thousands of dollars, as good as risk-free.

Unusually, at the moment fully featured three-year fixed-rate mortgages are cheaper than fully featured variable-rate mortgages...

The Commonwealth Bank, for example, advertises its three-year fixed-rate mortgage at 6.79 per cent. Its standard variable rate is 7.32 per cent, often discounted towards 6.81 per cent.

It should only make sense for a bank to offer a cheaper fixed-rate mortgage than a variable one if it expects the variable rate to fall. But the Commonwealth Bank, among others, expects the variable rate to rise. Its forecast is for an increase in the Reserve Bank-controlled variable interest rate within the next few months. None of the bank economists surveyed by Australian Associated Press last month expected the variable rate to fall.

So unless rates turn down quite dramatically in the years beyond the banks' forecasting horizons, switching from a variable-rate to a fixed-rate mortgage seems an extraordinarily attractive deal. Usually fixed rates are a bad deal.

The economist Nicholas Gruen has examined what would have happened to people who took out a three-year fixed-rate rather than a variable-rate mortgage for each month during the 1990s. He finds that 86 per cent of the time that decision would have cost the mortgage-holders money. They would have ended up paying more.

Banks build an extra profit margin into their fixed-rate mortgages. They do it partly because they can (it is very hard for ordinary customers to work out whether they are being overcharged) and partly because their customers are prepared to pay more for the certainty of fixed monthly repayments.

In his role as the head of the discount mortgage broker Peach Home Loans, Gruen had been advising his customers to stay away from fixed-rate products. Economic theory told him that the rate would be set at about the best guess of the future variable rates plus a profit margin.

Then he noticed something that unnerved him - the fixed rates were falling lower than made forecasting sense. As he put it in his newsletter to clients: the fixed rate no longer reflects the best expectation of future rates.

Since sharing this epiphany with his clients his business has changed direction. A year ago he was steering only 10 per cent of his clients into fixed-rate loans. Now it's 35 per cent.

He is not alone. Australia's largest mortgage wholesaler, AFG, is now putting one in five of its clients into fixed-rate mortgages. A year ago it was one in seven.

Surely there has to be some sort of catch. It could be that we are about to head into an unforseen economic downturn - even a recession - which will force the Reserve Bank to cut variable interest rates a year or so down the track. There's a lot of talk about this in the United States, which also has fixed rates that are lower than variable ones - a so-called "inverted yield curve". Professor James Smith of the University of North Carolina has several times been recognised as that nation's most accurate economic forecaster. He says an inverted yield curve has preceded each of the past four US recessions. In his words: "When the curve inverts, run for the exits."

The other view, subscribed to by Gruen and also by the new head of the US Federal Reserve, Ben Bernanke, is that these are indeed unusual times. The world is awash with excess savings, much of it from Asia, looking for a home. Bernanke calls it a global saving glut. In earlier days the money would have been invested in projects within Asia, but after the economic crisis there, those opportunities dried up. It has come flooding instead into countries such as the US and Australia which appear to have good prospects, allowing us to borrow incredibly easily. (And allowing Australia to clock up the near-record $2.47 billion monthly trade deficit for November revealed yesterday.)

When you borrow from an Australian bank or mortgage provider these days there is a high chance the money ultimately comes from a lender in Japan, China or the Middle East. So much of this foreign money is washing in to Australia that it appears to have landed unevenly. It is available to Australian financial institutions more cheaply for three-year terms than it is for immediate repayment.

For once, a low three-year fixed mortgage rate might signal nothing whatsoever about the future course of the variable rate. It might signal a genuine bargain - the unlikely equivalent of a $20 note lying on the ground.

But it mightn't last. As they become more popular, the price of fixed three-year mortgages is climbing. The Cannex research service reports that the Adelaide Bank is still offering a fully featured fixed three-year loan for 6.55 per cent. But that offer is about to end.

The notes on the footpath are being picked up.

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Wednesday, January 04, 2006

Why stopping smoking is hard

Every January perhaps as many as half a million people resolve to give up smoking. By the start of each February most of them are back on the cigarettes again. If, like me, you never started, thank your lucky stars. The latest economic research suggests that it's far more difficult to give up than had previously been believed.

Even people who think they are giving up may be filling their bodies with just as much nicotine as before. And some of the measures designed to cut back smoking and protect the rest of us may be counterproductive.

Each year 11,000 Australians take part in a survey run by the Melbourne Institute of Applied Economic and Social Research and originally designed to measure changes in income and working arrangements. It also asks participants whether they smoke.

Last year two of the institute's researchers, Hielke Buddelmeyer and Roger Wilkins, looked for common threads linking those Australians who had succeeded in giving up smoking between one survey and the next. The biggest was pregnancy. The biggest thread linking those Australians who had taken up smoking was divorce.

Then they examined the effect of the extra bans on smoking in public places introduced in some states... They found that while these encouraged older Australians and the very young to quit, people aged 18 to 24 were actually less likely to quit in those states in which a ban had been introduced.

This "rebellion" effect appears to pop up all over the place when it comes to fighting smoking. It had been thought that increasing the price of cigarettes would cut the number sold and improve the health of smokers. It certainly cuts the number sold. In Australia, a price increase of 10 per cent cuts sales by about 4 per cent. But a price increase doesn't necessarily cut the amount of nicotine taken into smokers' bodies.

Late last year an economist, Francesca Cornaglia, decided to measure nicotine levels directly, or as directly as she could. Continine is a byproduct of nicotine, present in saliva. With a colleague from the Institute for Fiscal Studies at University College London, she linked records of continine concentrations state by state in the United States with information on the number of cigarettes sold per person and their price.

She found that while increases in cigarette taxes did cut the number of cigarettes sold, they appeared not to cut at all the level of continine in smokers' saliva. As she put it: smokers were smoking fewer cigarettes but were smoking each one "more intensively".

Smokers appear to adjust by having more puffs from each cigarette, inhaling for longer and (perhaps subconsciously) blocking the ventilation holes on the filter. (Interestingly she found that so-called heavy smokers may not be smoking that heavily at all. After about 10 cigarettes a day, they smoke each extra one far less intensively in order to merely top up their nicotine levels while avoiding an overdose. They appear to have an inbuilt nicotine regulation mechanism.)

Cornaglia found that smoking intensity increased throughout the 1990s as cigarettes became more highly taxed, and that this itself may be a health hazard. Smoking down to the filter leads smokers to inhale more dangerous chemicals. And she found that it's the poorer, mainly black Americans whom higher prices have forced to smoke the most intensively.

Cornaglia then turned her attention to the level of continine in the saliva of non-smokers. Her findings have made her particularly unpopular among those who would like to ban smoking everywhere they could. She presented them to economists at the Australian National University in November.

She found that increases in the tax on cigarettes improve the saliva of non-smokers quite dramatically, especially the saliva of children exposed to their parents' smoke. Throughout the 1990s the number of non-smoking Americans taking in dangerous levels of nicotine halved. Higher cigarette prices improve the health of the rest of us.

But when it comes to banning smoking, a more complex picture emerges. Banning smoking on public transport, in shopping centres and in schools appears to improve non-smokers' health. But banning it in places where smokers "go out", such as restaurants and bars, makes the health of non-smokers worse. It pushes smokers away from those establishments and back into their homes where they pump smoke into the air breathed by their children and loved ones.

Cornaglia suggested a better public health measure would be to allow the creation of special smoking establishments where smokers could breathe smoke over each other. It is a suggestion unlikely to cut ice with NSW's crusading Minister for Cancer, Frank Sartor.

From mid-next year all areas of all hotels, clubs and nightclubs open to the public will be completely smoke-free. Smoking in the indoor areas of cafes and restaurants was banned in 2000.

But Cornaglia said it is more important to protect the health of children at home than the health of the non-smoking adults who choose to go into smoking establishments. Children at home have no say in their exposure to smoke, they are particularly prone to tobacco-related diseases, and if they are exposed they may do worse at school and earn less in later life.

As uncomfortable as her arguments may be to anti-smoking zealots, they are unlikely to be welcomed by the cigarette manufacturers. They have been arguing for years that second-hand smoke at home does no damage.

The latest economic research on smoking provides little comfort to anyone, and certainly not to anyone trying to give up as part of a new year's resolution. Short of getting pregnant there's no particularly successful way to do it, and merely cutting back won't make all that much difference to your health.

The best advice from the economics profession is to go cold turkey. Little wonder it's called the dismal science.

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