Thursday, June 21, 2018

Never mind the tax, it's wages that are making us glum

Why do they keep going on and on about tax when they must know it’s not our real concern? Because the sudden dive in wage growth – the thing that is really worrying us – is beyond their control.

As recently as 2012, just six years ago, wages were growing like they usually had, at a touch under 4 per cent per year. The rapid dive meant that by June 2014, two years later, they were growing at 2.4 per cent, the lowest rate since the last recession, and a good deal less than the lows plumbed during the global financial crisis.

Another two years later they were growing at just 2 per cent; even less than in the early 1990s recession, and on the face of it, the least since the Great Depression in the 1930s.

Yet we weren’t in a depression, or even in recession. And we kept buying houses and other things as if wage growth would recover. It needs to recover to make those home loans and car loans manageable.

Banks and finance companies have formulas they use to decide how much to lend. Unchanged since the days when workers could expect solid wage rises, they are based on income and the size of a deposit. Difficult to manage at first, home loans became easier to repay as the borrower’s income climbed, meaning many were paid off early. But not now, not unless wage growth picks up.

Banks are advancing 30-year mortgages to 50-year-olds. Without faster wage growth, a lot of those borrowers will remain mortgaged into retirement, and have much of their pension eaten up in payments, a fate their parents escaped.

Reserve Bank governor Philip Lowe touched on the phenomenon in a speech last week. His bank has even coined a name for it: mortgage tilt. Whereas required payments as a proportion of income used to tilt down over time, now they are more horizontal, meaning a long horizon of fairly constant payments. Unless interest rates climb, in which case payments will climb, which would be even worse.

And he pointed to something else. He said low wage growth was “diminishing our sense of shared prosperity”. When I first visited Japan in the late 1980s the locals seemed optimistic and proud to be part of something big. When I next visited in the late 1990s after a decade of near zero wage growth, their faces and stories were glum, even though by international standards they were prosperous and had jobs. Glum Australians feeling they are not part of the Australian project can derail the project, as we have seen in Britain and the United States.

Why should wage growth have dropped so suddenly, when the unemployment rate is little different to what it was back when it was high?

The first thing to note is that we are not alone. It’s been a shift throughout the developed world, with Japan getting in early. Improved communications have made competition from cheaper workers overseas a potent threat. Also, unions no longer have the bargaining power that they used to.

In the words of Andy Haldane, chief economist at the Bank of England: “There is power in numbers. A workforce that is more easily divided than in the past may find itself more easily conquered.” As recently as 1990, 40 per cent of the Australian workforce was in a union. Now it’s 14.5 per cent.

Unions no longer have the unfettered right to enter workplaces, or the right to demand special clauses in awards that benefit only their members. Strikes are illegal in most circumstances, and require notice and hard-to-organise ballots in others. The Fair Work Commission can no longer intervene to resolve disputes without the consent of the employer.

And although employment is strong, people are losing their jobs. Telstra is letting go of 8000, many in its Melbourne headquarters. The National Australia Bank is shedding 2000 each year for the next three years. The NSW public service will lose as many as 11,800 jobs as a result of efficiency measures in this week’s state budget. Few workers, in any of those organisations, are going to feel game to make themselves expensive.

The way Dr Lowe sees it, a small number of Australian firms are investing massively in the technology needed to do things more cheaply. A much greater number are not, and are having to fight off brutal price competition. The only way they can do it is to hold the line against wage increases, even at the cost of missing out on good staff.

Added to this might be what US economist Paul Krugman calls the scarring effect of the global financial crisis. He says employers discovered during the crisis that they couldn’t cut wages, even though they needed to. It wasn’t socially acceptable. It taught them that “extended periods in which you would cut wages if you could are a lot more likely than they used to believe”.

So they’re keeping wage costs low, in preparation for the next crisis. It’s an awful response, with political as well as economic implications.

Government forecasts notwithstanding, it is hard to see anything changing for quite some time. Glum is starting to look like the new normal.

In The Age and Sydney Morning Herald
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Monday, June 18, 2018

Work to barely pay for returning mothers, inquiry told

The third and final stage of the government's proposed income tax cuts would overwhelmingly benefit men, late evidence presented to the Senate inquiry shows.

The inquiry will report on Monday that calculations prepared by the Parliamentary Budget Office show 1.894 million men would benefit from the final flattening of the tax scales and only 767,000 women.

The third stage lifts the threshold for the top rate from $120,000 to $200,000 and removes the 37 per cent rate, producing a flat marginal rate of 32.5 per cent between $41,001 to $200,000.

The PBO has previously told the inquiry the final stage would deliver $30.35 billion to men over four years and $11.25 billion to women.

It finds that the impact of the first two stages is much more even.

In a second piece of late evidence requested by the committee, Melbourne University tax expert Miranda Stewart reports that the effective marginal tax rate facing women considering returning to work after having children would remain as high as 95 per cent even after all three stages of the tax cuts and the changes to child care benefits due to begin on July 1.

Effective marginal rates include tax, the Medicare levy, lost family benefits and the cost of the childcare needed to return to work after government subsidies.

On July 1 the two existing childcare subsidies will be rolled into one providing a means tested subsidy of up to $11.77 per hour at an extra cost to the budget of $4 billion over four years.

Professor Stewart said at the moment the effective marginal tax rate for a second earner with two young children paying for childcare at that rate was 65 per cent when returning to work one day a week, 85 per cent on the second day, 95 per cent on the third day and 140 per cent and 160 per cent on days four and five, meaning those families lost income when mothers moved from working part time to full time.

"It was extraordinary that second earners went back to work full time at all," she said. "The reality has been that a proportion of women do go back to work, and the family is essentially bearing the net cost, unless they can use grandparents or friends for care or a cheaper option such as family day care.

The combination of the new childcare system and the first wave of the promised tax cuts would bring down the effective marginal rates to 45 per cent for day one, 65 per cent for day two, 90 per cent for day three, 95 per cent for day four and 90 per cent for day five.

"It means the returning mother will still only be able to keep $10 out of every $100 earned on day three, $5 on day four, and $10 out on day five," Professor Stewart said.

"It will certainly be worthwhile for a second earner, usually a mother, returning to work with young children to go back two days a week; however, for her to work three, four or five days a week would produce a negligible financial benefit."

A separate report to be released by the Australia Institute on Monday finds that since the tax changes that accompanied the introduction of the goods and services tax in 2000-01, most taxpayers have had all of so-called bracket creep returned in periodic tax cuts, whether bracket creep is calculated with reference to the consumer price index or the wage price index.

In real terms, high earners on $200,000 were up to $10,000 per year better off, low to middle earners on $40,000 up to $2000 better off, and middle earners on $70,000 only a few hundred dollars a year better off.

In The Age and Sydney Morning Herald
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Thursday, June 14, 2018

Pink vs blue tax: the case for taxing women lightly

If women were to be taxed differently to men, it wouldn’t be the first time.

Treasurer Scott Morrison says the idea is absurd.

“You don’t fill out pink forms and blue forms on your tax return. It doesn’t look at what your gender is any more than it looks at whether you are left-handed or right-handed,” he said last week.

He even said, wrongly, that Labor has been suggesting it.

But such a move has happened before.

In Britain right up until 1971, wives weren’t usually taxed on their income; their husbands were. A wife’s income was deemed to be “stated and accounted for by her husband”. It wasn’t until 1950 that wives ceased to be classified for tax purposes as incapacitated along with “infants, lunatics, idiots and the insane”.

South Australia broke ranks early, in 1884, taxing married women as individuals and giving them the right to own property. By the time the Commonwealth introduced national income tax in 1915, all the states had fallen into line.

What possible modern-day reason could there be for taxing women differently to men, as mentioned by Melbourne University tax expert Miranda Stewart in evidence to the Senate last week?

Morrison himself provided a clue while ridiculing the idea. He said the Tax Act was designed “to treat people’s income the same, and so you pay tax according to what you earn”.

But we don’t. Someone who earns $1000 from wages pays twice as much as someone who earns $1000 by making a capital gain selling an asset. Income from capital gains is taxed more lightly in accordance with what’s known as optimal taxation theory. It suggests taxing heavily things that tax is unlikely to stop, such as work, and taxing more lightly things that tax is more likely to stop, such as the movement of capital. It’s the basis of the argument for a lower company tax rate as well as a lower capital gains tax rate.

The concession isn’t “fair”, but it’s efficient.

As would be the logical extension, which is to tax female wages more lightly than male wages. Male work turns out to barely react to after-tax pay. Most men will continue to work full-time regardless of what happens to what they take home, regardless of how much they grumble.

Some will work a bit less if their take-home pay falls, because they are offered less of a reward. Others will work a bit more in order to get back the income they lost. On balance the “price elasticity” of their labour is close to zero.

Women are different. Most European and American estimates put the price elasticity of their labour between 0.4 and 1, meaning a 10 per cent boost in their take-home pay will lift their hours of work by between 4 per cent and 10 per cent.

The most efficient way to tax labour would be to heavily tax generally unresponsive male work and more lightly tax generally highly responsive female work, depending on elasticities. Economists Alberto Alesina from Harvard University and Andrea Ichino from the University of Bologna in Italy believe women should be taxed at no more than 80 per cent of male rates in the US, at no more than 68 per cent in Italy and no more than 91 per cent in Norway.

And there’s another argument for discriminating on the basis of gender. It’s that, for most of us, gender is innate. We won’t change it. Tax theorists say that, ideally, we should be taxed on our underlying ability to earn an income rather than the income itself. Otherwise some of us with ability will avoid tax by avoiding earning an income. Although the ability to earn is hard to measure, markers for it are easy to measure, such as height.

In a half tongue-in-cheek paper entitled The Optimal Taxation of Height, Harvard economists Gregory Mankiw and Matthew Weinzierl note that someone who is 183 centimetres tall can expect to earn $US5500 ($7300) more per year than someone 165 centimetres tall. They say tall people should pay several thousands more in tax than short people on the same income. It’s a way of getting at their earning capacity, as would be a higher tax on the earnings of men.

And there’s yet another practical reason to tax women more lightly. The withdrawal of family benefits and the imposition of childcare costs as mothers return to work mean some face extraordinarily high “effective” marginal tax rates of up to 90 per cent. If ever there were people who ought to be affected by high tax rates, it’s returning mothers.

But here’s what’s odd. Australian mothers are hardy. When the Productivity Commission recommended a new, simpler and more generous formula for childcare support along the lines of the one introduced in this year’s budget, it found it would boost employment by just 15,000 full-time worker equivalents in a workforce at present growing by hundreds of thousands per year. More than mothers in the United States, Germany and Britain, Australian mothers seem undaunted by tax rates. The case for treating them gently is strong in theory, weak in practice.

In The Age and Sydney Morning Herald
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Thursday, June 07, 2018

The case for destroying default super in order to save it

So toxic has much of Australia’s superannuation industry become that some at the very top of the government think the Productivity Commission hasn’t gone far enough.

The commission wants to unpick the link between super funds and jobs, meaning everyone would need only one fund for life that they could choose from a dropdown menu of the top 10 (or pick another fund if they want to, or set up their own).

It can be thought of as a way of saving the house, chopping away some of the rotten wood. The alternative, being seriously considered by ministers including Financial Services Minister Kelly O’Dwyer, would be more like burning it down. It would be to set up a single government-run default scheme to which everyone would belong for life, until they decided otherwise.

If it were well run there would be little room for funds run by the scandal-plagued banks and AMP, and less room for industry funds.

The national default scheme would operate like the government-run Future Fund, which invests billions to fund payouts from now-closed public service superannuation schemes.

It might even outsource some of its work to the fund. But it would be much bigger; perhaps as big as $1 trillion, and eventually several trillion, compared to the Future Fund’s $141 billion.

Like the age pension, its payouts would be provided by the government and funded by tax. But, unlike the pension, the contributions wouldn’t be called a tax, just as super contributions aren’t called tax at the moment. And what’s paid out would depend on what was paid in, meaning the highest earners would get the most, unlike the pension, which is meant to be the other way around.

(Going further and abolishing government-mandated superannuation altogether and just paying everyone the pension would be the next logical step, and would easily pay for itself given the cost of the super tax concessions, but as far as I know I am one of the few people suggesting it, and I am fairly sure no one in government is.)

Lying behind the idea is the realisation that the bank-owned funds are far worse than the headline figures presented by the Productivity Commission suggest, and that the banking royal commission is about to make this clear.

What is already well known is that the bank-owned funds perform poorly. Over the past decade the largely bank-owned "for profit" funds have produced annual returns of 4.9 per cent compared with the industry funds' 6.8 per cent and the Future Fund’s 8.5 per cent. Over a lifetime this would mean a typical retail fund paid out less than half as much as a typical industry fund.

The banks have got people into their poorly performing funds by paying their staff commissions, by paying advisers commissions and by buttering up employers with offers of good banking terms.

But those extra costs don’t come anywhere near explaining their poor performance. The commission’s intriguingly named 'Technical Supplement 4: Investment Performance Methodology and Analysis" provides hints. It says retail funds produce annual returns 0.9 per cent worse than would be expected given their asset allocation strategies, and industry funds produce returns 0.2 per cent better given their strategies.

But they are different strategies. As a matter of policy the retail funds have adopted approaches that give less weight than the industry funds (or the Future Fund) to the asset classes that have been shown to perform the best over the long term: things such as toll roads and well-tenanted buildings.

It’s partly because of cost. Being for-profit funds, and charging (hefty) administration fees, they don’t want to use up those fees on the cost of inspecting and directly investing in buildings. It’s cheaper to buy a share index, and cheaper still to buy government bonds.

If your own institution is selling them at a good price for it, so much the better. And shares are more liquid than buildings, which means bits of them can be easily sold and re-bought; something that’s needed if you are offering thousands of different investment options for people to switch into and out of, each time earning you a fee.

It’s got to the point where some in the Coalition believe it is no longer possible to defend the bank-owned funds. They’re saying that if the industry funds are better because they’ve generally got more scale and take the job seriously, a single national default fund would be better still. As Peter Costello, the chair of the Future Fund and Australia’s longest serving treasurer, puts it, “one default fund could make large allocations and use market power to drive down costs”. There’s one in Canada, and in Britain.

The counterargument, put by Productivity Commissioner Karen Chester, is that a government-run fund would acquire an implicit government guarantee which could make it overly cautious, reluctant to lose money. And she says 27 years of compulsory super has given us something worth salvaging: a modicum of interest in what happens to our money.

It’s far from certain that what she is proposing will get the government’s nod. So bad are the ongoing revelations about the funds that Costello is in there with a chance.

In The Age and Sydney Morning Herald
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Saturday, June 02, 2018

Portrait of a sick system is chance to put things right

We’re apathetic about super, until we’re not.

On Tuesday phone lines to Australia’s biggest bank-run super funds buckled under a deluge of calls from customers wanting to close multiple accounts. Traffic to the Australian Securities and Investments Commission’s website for consolidating your super jumped 500 per cent.

And in at least one school, Year 12 students were shown two videos; one produced by the Productivity Commission depicting super funds as pigs, and the other prepared by this newspaper, making the point that multiple and poorly chosen accounts can cost members in excess of $400,000 over their working lives.

Asked to check in on their own accounts as homework, some discovered they already had more than one. They had been working casually, flipping burgers and selling clothes. Each new account furnished them with a new insurance policy, which sounds like a bonus until you realise they were getting insured more than once against death and losing their income. They were aged 16 and 17.

Every additional insurance policy, whether junk or not, costs $85,000 over a working life, according to the Productivity Commission report that set off the avalanche of calls. (In reality many wouldn’t cost that much, because they would drain inactive accounts first.) That super funds have knowingly allowed multiple insurance policies to accumulate in the accounts of people too young to benefit is one of a number of scandals uncovered in the report.

The commission’s suggested solutions to the problems of multiple and unsuitable insurance policies are simple: funds would be prevented from foisting them on anyone aged under 25 without their consent; inactive accounts would have their policies stopped. People with inactive accounts are almost certain to have another active account with insurance or no income to insure.

Treasurer Scott Morrison commissioned the inquiry a year ago, at a time when he was still implacably opposed to a banking royal commission. Its head, Producitity Commission deputy chair Karen Chester, refers to it as the “not-so-royal commission”.

Morrison wanted it to examine the costs, fees and net returns of super funds, the role of insurance premiums in eroding member balances, and the antiquated way in which people are pushed into default funds that are tied to jobs, not people. The lines between the two commissions will blur in the coming weeks, as the banking royal commission itself turns its attention to super.

Tuesday’s report is a draft. The Productivity Commission can’t be certain when it will deliver the final report partly because the banking royal commission is taking up so much of bank executives’ time that it would be unfair to ask them to deal with the super report until the banking inquiry is out of the way. But the commission is keen to hear from the rest of us immediately.

On Friday it added a new ‘Brief Comments’ section to its website. Ordinary Australians will be able to upload up to 200 words without the need to make a formal submission. Their names won’t be published but, if they agree, their comments will be. When Chester did this before in an earlier superannuation inquiry, she was able to put the lived experience of Australians to fund representatives in public hearings and get them to concede that things weren’t as rosy as they had been suggesting.

Their investment performance is disheartening. Super funds are made up of asset classes; things such as property, shares, international shares and government bonds, assembled in certain proportions.

By examining the average performance of each of the underlying asset classes and assembling them in the same proportions as each of the regulated funds - in what it thinks is a world first - the commission has been able to compare what the fund’s performance would have been if no special skill had been added with the results they actually delivered over more than a decade, taking account of fees and tax.

Shockingly, it found that the 228 funds taken together (accounting for 93 per cent of all accounts and 61 per cent of all superannuation assets) did worse than if the managers had just set the proportions and then done nothing. Their attempts to pick stocks consistently cost their members money. Without putting too fine a point on it, their members would have been better off paying them to do nothing.

The retail funds, mostly run by the banks, are the worst. Instead of producing the 6 per cent per year they would have if they had just set their asset allocation and sacked their stock pickers, they produced 5 per cent. (Stock pickers in the union and employer-controlled industry funds did add value, but not much, boosting annual returns by 0.2 percentage points.)

The commission says it’s at a loss to understand how the retail stock pickers can be so bad. On the face of it it would take a rare and perverse skill to consistently produce worse results than leaving things alone. Keen readers of the Productivity Commission website will find a clue in one of the submissions, from Kevin Liu and Elizabeth Ooi at the School of Risk and Actuarial Studies at the University of NSW.

Despite their complaints about how the directors of industry funds aren’t independent (most are employer and union representatives), most of the directors of retail funds aren’t independent either. Four out of five are affiliated to the bank or larger entity that owns the fund, often by working for another part of it.

Liu and Ooi find that the more affiliated directors a retail fund had, the worse it performed. And the more related-party service providers it used, the worse it performed. The effect was “both statistically and economically significant, and consistent across different measures of investment performance”. The implication is that affiliated directors put the interests of the bank or larger entity first, perhaps by loading up super funds with products it wanted to shift.

Looked at this way, the superior performance of the industry funds isn’t so much the result of superior skill as it is the result of doing a job well in a straightforward way without a conflict of interest.

It’s also the result of scale. Many of the retail funds are deliberately small. There are around 40,000 of them, a number so big as to almost certainly be designed to confuse and beguile the customer rather than help. It’s no accident that Australia’s biggest industry fund, AustralianSuper, is always one of the top performers.

But some of the industry funds are also small, and are shockers when it comes to performance, sitting alongside the worst of the bank-run funds. Appallingly, new employees and people switching jobs continue to get funneled into them because of the provisions of industrial awards. For as long as that happens their directors will be tempted to keep them open, pocketing board fees for running an organisation that stays subscale but open as the trickle of members leaving is replaced by a stream coming in.

It’s why the commission wants super to follow the person, not the job, with every new labour market entrant (and everyone changing jobs) presented with a list of the top 10 funds and invited to pick and stick for as long as they like, without accumulating multiples. Labor and the Coalition have cautiously welcomed the idea.

It is competing with another model, proposed by Future Fund chair Peter Costello, in which the government would run the only default fund, freezing the top 10 out. It says a lot about how bad the performance of the bank-owned funds has been that some in the Coalition are prepared to countenance it - and also a lot about how much they despise the top-performing union and employer-controlled industry funds.

Australia’s superannuation system is 25 years old. The pool of super savings has climbed to $2.6 trillion. By 2030 it’ll be $5 trillion. It’s important to get it right.

In The Age and Sydney Morning Herald
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