Inheritance taxes, resource taxes and an attack on negative gearing: how top economists would raise $20 billion per year

Asked to find an extra A$20 billion per year to fund government priorities like building nuclear submarines and responding to climate change, Australia’s top economists overwhelmingly back land tax, increased resource taxes, an attack on negative gearing and extending the scope of the goods and services tax.

The 59 leading economists surveyed by The Conversation and the Economic Society of Australia were asked to pick from a list of 13 options (many of them identified in the government’s 2022-23 Tax Expenditures and Insights Statement) and reply as if political constraints were not a problem.

The economists chosen are recognised as leaders in their fields, including economic modelling and public policy. Among them are former International Monetary Fund, Treasury and OECD officials, and a former member of the Reserve Bank board.

Asked to choose tax measures on the basis of efficiency – minimising the economic damage the extra taxes or tightening of tax concessions would do – 40% chose increased or new taxes on land, while 39% choose increased resource taxes.

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International consultant Rana Roy said every major economist in every strand of modern economics had found taxes on the use of land and natural resources to be the least damaging way of raising money.

This was confirmed in Hong Kong, which charged for the use of crown land; in Norway, which heavily taxed oil and gas resources; and in countries such as Australia, which charge for the use of broadcast spectrum.

Former OECD official Adrian Blundell-Wignall said Australia’s natural resources were the birthright of every Australian. It was time for a resource rent tax along the lines of the one introduced by the Rudd and Gillard governments and abolished by the Abbott government in 2014.

Blundell-Wignall said politicians should ignore the usual hysteria that arose whenever the idea was discussed.

Centre for Independent Studies economist Peter Tulip said he would lump income from inheritances in with income from changes in land value. In both cases the income was unexpected, undeserved, and not compensation for sacrifice. And it disproportionately went to the already fortunate.

Negative gearing an ‘easy win’

A quarter of those surveyed backed winding back the ability to negatively gear (write off against tax) expenses incurred in owning investment properties, a concession costed by Tax Expenditures Statement at $24.4 billion per year.

Blundell-Wignall said negative gearing should have been wound back years ago. Few other countries allowed it, and it contributed to the build up of exposure to property in Australia’s banking system and financial risk as interest rates climbed.

University of Sydney economist James Morley described getting rid of negative gearing as an “easy win”. There were better ways to support home building.

Independent economist Saul Eslake said while he was inclined to extend capital gains tax to the sale of high-end family homes, the problem with the idea was that it might allow owners to write off against tax their mortgage payments (as is the case for investors who negatively gear), encouraging even larger mortgages.

One quarter of those surveyed wanted to broaden the scope of the goods and services tax (at present it excludes spending on education, health, childcare and fresh food) and one fifth wanted to increase the rate, pointing out that a 10%, it was low by international standards.

‘Unfair’ super concessions and tax-free inheritances

Asked to choose measures on the basis of equity – not treating similar people differently – 52% backed inheritance taxes, 37% backed winding back superannuation tax concessions and 32% backed increased resource taxes.

None would broaden the GST on equity grounds, and only 3.4% would increase its rate on equity grounds.

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Grattan Institute chief executive Danielle Wood said two-thirds of the value of super tax breaks went to the top fifth of income earners, who are already saving enough for their retirement and would do so without tax concessions.

Wood said the government should go further than the measures taken against super accounts worth more than $3 million announced in February.

The University of Adelaide’s Sue Richardson said super concessions had a negative impact on budget revenue, amounting to tens of billions per year. They were used for tax minimisation by high earners who obtained expensive advice.

Missing fixes: Stage 3 and a carbon tax

Guyonne Kalb of the University of Melbourne said the most important tax measure for fairness was one not listed as an option: scrapping the legislated “Stage 3” tax cuts for high earners, due to take effect in 2024.

The tax cuts scheduled for people earning between $120,000 and $200,000 would not have much or any positive impact on Australia’s labour supply and would cost the budget more than $100 billion in their first seven years.

Three panellists, Frank Jotzo, Michael Keating and Stefanie Schurer, said they would have selected “carbon pricing to raise revenue” had it been an option.

Jotzo said if Australia fully taxed emissions at $100 per tonne, the revenue would be around $15 billion per year from electricity, $18 billion from industry, and $9 billion from transport – very large sums in relation to other options.

Schurer would also take away all subsidies to fossil fuel industries. In 2021-22 measures that wholly, primarily or partly assisted fossil fuel industries cost federal, state and territory governments $11.6 billion.

If the government needed $20 billion per year, it could raise around half from fossil fuel subsidies alone.

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Individual responses:

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How can Australia pay $368 billion for new submarines? Some of the money will be created from thin air

Australia’s decision to buy three nuclear-powered submarines and build another eight is so expensive that, for the A$268 billion to $368 billion price tag, we could give a million dollars to every resident of Geelong, or Hobart, or Wollongong.

Those are the sort of examples used by former NSW treasury secretary Percy Allan on the Pearls and Irritations blog, “in case you can’t get your head around a billion dollars”.

Such multi-billion megaprojects almost always go over budget.

For instance, when Prime Minister Malcolm Turnbull announced the Snowy Hydro 2.0 pumped hydroelectricity project in 2017, it was supposed to take four years and cost $2 billion. The latest guess is it’ll actually take 10 years and cost $10 billion.

So to pay for those two megaprojects alone, there’s an awful lot of money we will need to find from somewhere. Or will we?

‘No simple budget constraint’

In the first year of the pandemic, Australians were given a glimpse of a truth so unnerving that economists and politicians normally keep to themselves.

It’s that, for a country like Australia, there is “no simple budget constraint” – meaning no hard limit on what we can spend.

“No simple budget constraint” is the phrase used by Financial Times’ chief economics commentator Martin Wolf, but he doesn’t want it said loudly.

The problem is, he says, “it will prove impossible to manage an economy sensibly once politicians believe there is no budget constraint”.

A quick look at history shows he is correct about there being no simple budget constraint, despite all the talk about the need to pay for spending.

As you can see below, Australia’s Commonwealth government has been in deficit (spent more than it earned) in all but 17 of the past 50 years. The US government has been in deficit for all but four of the past 50.

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Commonwealth government surpluses and deficits since 1901

Ashley Owen, Stanford Brown

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There is no hard limit on how the Commonwealth can spend over and above what it earns, just as there’s no hard limit on how much you and I can spend. But whereas you or I have to eventually pay back what we have borrowed, governments face no such constraint.

Because the Commonwealth lives forever, it can keep borrowing forever, even borrowing to pay interest on borrowing. And unlike private corporations, it can borrow from itself – borrowing money it has itself created.

Governments create money

That’s what the Morrison government did in 2020 and 2021, in the early days of COVID.

To raise the money it needed for programs such as JobKeeper, the government sold bonds (which are promises to repay and pay interest) to traders, which its wholly-owned Reserve Bank then bought, using money it had created.

The government could have just as easily cut out the traders and borrowed directly from its wholly-owned Reserve Bank, using money the bank had created – effectively borrowing from itself. But the Reserve Bank preferred the appearance of arms-length transactions.

And there’s no doubt the Reserve Bank created the money it spent, out of thin air.

Asked in 2021 whether it was right to say he was printing money, Governor Philip Lowe said it was, although the money was “created”, rather than printed.

People think of it as printing money, because once upon a time if the central bank bought an asset, it might pay for that asset by giving you notes, you know, bank notes. I’d have to run my printing presses to do it. We don’t operate that way anymore.

These days the Reserve Bank creates money electronically. It credits the accounts of the banks that bank with it.

One way to think about it (the way so-called modern monetary theorists think about it) is that none of the money the government spends comes from tax.

The government creates money every time it gets the Reserve Bank to credit the account of a private bank (perhaps in order to pay a pension), and destroys money every time someone pays tax and the Reserve Bank debits the account.

If it creates more money than it destroys, it’s called a budget deficit. If it destroys more than it creates, it’s called a budget surplus.

Too much spending creates problems

Can the government create more money than it destroys without limit? No, but where it should stop is a matter for judgement.

If it spends too much money on things for which there is plenty of demand and a limited supply, it’ll push up prices, creating inflation.

Where to stop will depend on how much others are spending.

If there’s little demand (say for builders, as there was during the global financial crisis) the government can safely spend without much pushing up prices (as it did on builders during the global financial crisis).

If it wants to spend really big (say on building submarines), it might have to restrain the spending of others, which it can do by raising taxes.

What matters is what others are spending

But it’s not a mechanical relationship. The main function of tax is not to pay for government spending, but to keep other spenders out of the way.

If the economy is weak in the decades when the subs are being built, the burst of government spending will be welcome, and needed to create jobs. There will be no economic need to offset it by raising tax.

But if the economy is strong, so strong the government would have to bid up prices to get the subs built, it might have to push up tax to wind other spending back.

This truth means there’s no simple answer to the question “how they are going to pay for subs?” – just as there was no simple answer to questions about how to pay for a much-needed increase in the JobSeeker, or anything else.

The deeply unsatisfying answer is that, from an economic perspective, it depends on who else is spending what at the time.

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Working Australians pay tax in real-time – now the richest Australians making capital gains should too

In drawing up his plans to more effectively tax large superannuation accounts, Treasurer Jim Chalmers might have stumbled upon a really good idea.

If applied more broadly, it could at last tax rich Australians in something like the same way as the rest of us.

The wealthiest Australians are taxed differently from other Australians, because they earn much of their money in a different way.

Most of us get taxed at standard rates on the only income we have: income from working, and interest on savings in bank accounts.

High-wealth Australians make a lot of their money in other ways: from investments in shares and properties. And while the dividends from shares and the rental income from properties are taxed at standard rates, what happens to profits made by selling those shares and properties is anything but standard.

How capital gains are taxed differently

The profits made from buying and selling shares and properties are called “capital gains”. Until 1985, most of them were untaxed.

Sure, a section of the Tax Act said if you made a profit selling an asset after less than a year you would pay tax – but you could avoid that by waiting for more than a year. It also said if you sold something for the purpose of making a profit you could be taxed, but you could avoid that by saying profit wasn’t your purpose.

The capital gains tax, introduced in 1985, changed that.

Income from the profits made from buying and selling shares and properties was taxed as income – but with two important exceptions.

Rewriting one exception to the rules

One of those exceptions was that less of the income would be taxed than for other types of income. At the moment only half of each capital gain is taxed.

(During its unsuccessful 2016 and 2019 election campaigns, Labor promised to halve the discount, meaning 75% of each gain would be taxed.)

The other exception – the one Chalmers is breaking ground by winding back when it is used by super funds – is that the tax is only due when the asset is sold.

This is quite different to the way tax is charged on interest earned in bank accounts. We pay as the interest accumulates, not years or even decades later when the money is withdrawn.

The 2010 Henry Tax Review saw this special treatment as a problem.

A better deal than most Australians get

The Henry Review said collecting tax only on “realisation” (when assets were sold) rather than “accrual” (as they grew in value) encouraged investors to hold on to shares and property to delay paying tax – a response it called “lock-in”.

All the better for the investors if, when they eventually sold, they had retired and were on a much lower tax rate, meaning they would scarcely pay any tax on decades worth of gains.

During financial crises when prices fell, the rules encouraged investors to do the reverse – to sell quickly to realise tax losses, destabilising markets.

Henry would have preferred tax to be collected as the gains accrued, but said back then that wasn’t practical.

While improvements in technology might improve things, in 2010 it was hard to get a good read on changes in the value of buildings or rental properties until they were sold.

Real-time collection has become easier

Not now. Firms such as CoreLogic revalue property daily, and not just in the general sense. If you want to know what has happened to the value of a three-bedroom home with two bathrooms, on a particular size block of land, in a particular street, CoreLogic can tell you.

And real-time values are being used for all sorts of purposes. Pensioners owning rental properties get their value updated annually for the pension assets test. Services Australia doesn’t wait until they are sold to declare they are worth more.

It is the same with council rates. Property values are updated annually, rather than down the track when they change hands. There’s no longer a practical impediment to doing this, and there’s never been a practical impediment to valuing shares. They are valued daily on the stock exchange.

Finally taxing super funds in real time

That’s the simple approach Chalmers has now taken to valuing super fund income for the purpose of imposing the 15% surcharge on high balances, as announced a fortnight ago.

Rather than taxing capital gains only when assets are sold (as will still happen for the bulk of what’s in super accounts), the surcharge will be calculated by applying a 15% tax rate to the increase in the value of the relevant part of each fund. Super funds are already valued quarterly.

Chalmers isn’t talking about doing it more broadly. But what he is doing shows it would be fairly easy.

An option for Australia

Denmark is planning to do it this year, becoming the first country in the world to introduce what it calls the “mark to market” taxation of real estate capital gains.

Adopting the same approach in Australia would create difficulties that would have to be worked through, perhaps by providing loans. Some property owners wouldn’t have enough ready cash to pay an annual capital gains tax, just as some don’t have enough ready cash to pay rates.

But mark to market taxation of real estate capital gains would have benefits.

It would make investment properties less attractive, putting downward pressure on prices and making it easier for homeowners to buy. And it would make the tax system fairer by preventing wealthy Australians from postponing tax until their tax rate was low, raising much-needed money.

Following Denmark’s lead is not going to happen in a hurry – if at all. But by moving in that direction, Chalmers has brought fairer taxation of capital gains for all Australians a little closer than before.

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Why RBA interest rate hikes could end by September – but brace for at least one more

Tuesday’s tenth successive Reserve Bank interest rate hike is the culmination of a process that has added $1,080 to the monthly cost of payments on a $600,000 variable mortgage.

I’ve calculated this increase in payments – which amounts to $12,960 per year – by comparing payments on the National Australia Bank’s base variable mortgage rate before the Reserve Bank started its series of hikes in May 2022 with payments after the NAB lifts its rates in accordance with Tuesday’s decision.

Before the Reserve Bank started hiking in May 2022, the NAB rate was 2.19%. After nine Reserve Bank hikes, ahead of Tuesday’s meeting, it was 5.24%.

It will soon be 5.49%, meaning the monthly payment on a 25-year $600,000 NAB base variable mortgage will have climbed from $2,600 to $3,680.

And Tuesday’s statement from the Reserve Bank indicates there’s more to come.

But an end to these rate rises is within sight – possibly as soon as mid-September.

Bank on at least 1 more rate rise

The best guide to what the Reserve Bank has in mind is usually the first few words of the final paragraph of its statement.

Last time, in February, those words referred to further interest rate “increases”, making it clear the bank expected more than one.

This time, there’s no plural. The sentence refers merely to “further tightening”, which could mean as little as one more increase, and not necessarily next month.

The statement, like the last, says rate hikes work “with a lag, and that the full effect of the cumulative increase in interest rates is yet to be felt in mortgage payments”. That’s a reference to the large number of borrowers who are about to be hit with higher payments as they come off low fixed rates.

And, unlike the last statement, this one says inflation may have peaked.

So there are reasons for easing off, but also – as I’ll explain shortly – important institutional forces propelling Governor Philip Lowe to keep going.

Reasons for easing off on further rate hikes

The whole point of the dramatic interest rate hikes has been to make sure Australia’s sudden reemergence of high inflation is only temporary.

Inflation hit 7.8% in December, well outside the Reserve Bank’s 2-3% target zone and the most since 1990.

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The good news is to the extent that inflation comes from overseas in the prices for fuel and other imports, it seems to be easing.

US inflation has been falling for seven months now, from a high of 9.1% in June to 6.4% in January. UK inflation has been falling for three months, from 10.1% to 9.1%.

To the extent that inflation is driven by a surge in spending at home, that surge has stopped. Retail spending has been flat (unchanged) for four months notwithstanding a growing population and growing prices.

We’re winding back spending

This means what’s bought per person is falling, as would be expected if we were tightening our belts in response to higher interest rates and higher prices.

In February consumer confidence, as measured by Westpac and the Melbourne Institute, dived to its lowest point since the 2020 COVID recession.

Asked whether now was a good time to buy a major household item, only 17% of Australians surveyed said yes. Twice as many – 39% – said no.

Last week’s national accounts showed gross domestic product, the official measure of everything earned, bought and sold in the economy, climbing only 0.5% in the three months to December.

But buried in the fine print was something worse. Were it not for a fall in imports in the December quarter, GDP would have gone backwards.

It is one of the truly bizarre mathematical oddities of the way the GDP is calculated that a fall in imports boosts measured GDP, even though it is a sign we are tightening our belts.

And we’ve been having to tighten our belts. Wage figures released since February’s board meeting show growth of just 3.3% in the year to December, way below the increase in prices, and way below the entrenched growth of 5% the governor has said would concern him.

One of the reasons wages aren’t yet climbing particularly fast is that (unusually) wage earners expect inflation to fall. Throughout most of its life, the Melbourne Institute survey of inflation expectations has pointed to higher inflation than was actually experienced. At the moment it is pointing to lower inflation.

Nevertheless, the RBA board “remains alert to the risk of a prices-wages spiral” according to Tuesday’s statement. This implies it isn’t yet reassured by the official figures and that its liaison program with 600 or so business operators has identified increases yet to come.

6 months left to leave a legacy

That’s the economics, which points to taking things gently on rate rises from here on. But as I mentioned, there’s something else at play that might propel Governor Lowe to keep going a little further.

Governor Lowe’s five-year term expires on September 17. As his predecessor did, he would like to hand over the bank in good order.

That means having clearly broken the back of runaway inflation. It might mean going harder for longer on interest rate rises than he otherwise would to get things in order. It’s what his predecessor did for him in August 2016.

Glenn Stevens cut interest rates one last time before he left office to make sure Lowe didn’t take over the bank having to do it himself. Lowe left rates unchanged for almost three years. He had been handed the keys to a car in working order.

Seen this way, Lowe’s determination to be sure inflation is on the way down before leaving office is a matter of etiquette. He has six months left to get his house in order.

It’s a consideration that might mean more mortgage rate pain than would have been the case had Lowe not been near the end of his term.

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