Australian households ‘world-beating borrowers’

When Atlassian co-founder Mike Cannon-Brookes reportedly paid close to $100 million for the Fairfax family home in Point Piper this past week, it helped confirm that housing in Sydney and Melbourne has become seriously expensive.

The world’s longest property upswing (55 years and counting according to the Bank for International Settlements[1]) and a surge of more than 60 per cent in the past five years (notwithstanding a modest downturn in the last 12 months) will do that.

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But just how expensive has Australian property become?

One way to look at it is how much buyers have to borrow to be able to afford a home in Australia, and on this front recently-released figures compiled by the International Monetary Fund[2] provide an intriguing insight.

They show that, when it comes to going all-in to buy a house, no-one comes close to Australian borrowers.

In the three months to June, almost two-thirds of all loans (by value) in Australia were mortgages, which is far higher than any other nation for which the IMF has published figures.

Of the 79 other countries, including 23 advanced economies, that provided financial data to the IMF for the June quarter, none had a home-to-total-loan ratio above 46.3 per cent – a figured dwarfed by Australia’s 63.7 per cent.

The huge share of loans that are for mortgages isn’t being driven by more people borrowing. In fact, the number of owner occupiers taking out loans has been remarkably stable over time. In July 2005, there were 55,123 such borrowers. Twelve years later, in July 2017, there were 54,881.

But over that same period, the proportion (by value) of all loans that were for housing jumped from 56.3 to 63.75 per cent. Some of this growth was surely down to more investors getting into the property market. But the biggest driver was likely to be the surge in house prices over that time.

The preparedness of homebuyers to borrow so heavily to buy housing indicates a number of things:

  • a belief that a mismatch between supply in demand in key city markets will persist;
  • that this mismatch will drive house values up in the longer term;
  • that a mixture of fear and greed is at play – fear of being permanently priced out of the property market, and strong desire to grab a share of housing capital growth; and
  • that residential property will deliver better returns than other asset classes (noting that many are exposed to the sharemarket through their superannuation accounts).

The heavy borrowing required to compete in the recent property market has, of course, made households heavily indebted.

Household debt as a proportion of gross domestic product was at 104.9 per cent in the middle of the year, according to the IMF (Trading Economics/Bank for International Settlements reported it was 122.2 per cent)

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Current low interest rates have until now helped households carry this burden without too much distress, and less than 1 per cent of loans are ‘non-performing’. This is a world away from the situation in European countries hit hardest by the GFC, who are still climbing out from under their debt mountains. In Italy, for instance, more than 14 per cent of loans are still considered non-performing, and in Greece the ratio is a disastrous 45.6 per cent.

But the Reserve Bank of Australia, for one, sees, the level of household debt as a risk for the economy.

As a proportion of disposable income, the central bank warns it is high. The slowdown in wealth accumulation from the cooling property market, along with stagnant wages, has the RBA concerned that household consumption – a key driver of economic growth – could be weaker than it expects.

Moreover, others warn that a significant proportion of borrowers will struggle financially as interest only-loans transition into standard principle-and-interest mortgages in the coming year or so.

Against this, the jobs market is tightening, and there are nascent signs that wages are finally picking up.

The RBA’s core scenario is for above-trend growth driven by solid business investment and a gradual improvement in household consumption, which is underpinned by bigger pay packets, more jobs and low interest rates.

But the not-insignificant risks to this outlook posed by high household debt mean the current period of monetary policy stability – the RBA’s cash rate of 1.5 per cent hasn’t changed in more than two years – is set top continue for a while yet.

 

 

[1] https://www.smh.com.au/business/banking-and-finance/bis-says-australias-55year-house-price-upswing-the-longest-in-the-world-20171016-gz1kdc.html

[2] http://data.imf.org/regular.aspx?key=61404589

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Outlook for property prices: lower for longer?

By Adrian Rollins (this story was first posted by intheblack.com on 7 August 2018, at: https://www.intheblack.com/articles/2018/08/07/outlook-property-prices)

What is the outlook for Australian property prices now that the property market has passed its peak? Will house prices continue to deflate in key markets?

For a country used to ever-rising property prices – they have soared more than 370 per cent in the past 30 years – a new reality of shrinking property values and is taking shape.

Since the market peaked in September 2017, the home value index compiled by property market analyst CoreLogic has slid 1.3 per cent, including a 0.2 per cent decline in June 2018.

The searingly hot Sydney market has been hardest hit. House prices there have tumbled 4.6 per cent since the peak.

Nevertheless, so far the damage to balance sheets has been limited. Nationally, longer-term homeowners have held on to virtually all of their capital gains – prices are still 32.4 per cent higher than they were five years ago.

The property market is deflating, but with a gentle hiss rather than a cacophonous bang.

Nervous mortgage holders and aspiring homebuyers nonetheless wonder how long this decline will last, and how ugly it might get.

Applying the brakes to property prices

Part of the answer lies in understanding what pushed prices so high in the first place, and why they have since turned down.

CoreLogic research director Tim Lawless says easy credit and eager investors underpinned much of the increase in recent years. Buoyed by low interest rates and strong capital gains, investors piled into the property market.

By early 2015, the value of mortgages taken out by investors outstripped those to owner-occupiers, many of them riskier interest-only loans.

At one point, almost half of all loans being written were interest-only.

However, the downturn in house prices has not been driven by higher interest rates or borrowers getting into financial distress. Instead, it has been engineered by regulators, says property analyst Pete Wargent of WargentAdvisory.

Worried by the surge in investor borrowing, financial regulator the Australian Prudential Regulation Authority (APRA) in 2014 placed a 10 per cent speed limit on the growth of loans to investors. Three years later the regulator clamped down on interest-only lending, which had been growing rapidly, imposing a 30 per cent cap on the proportion of new mortgages that could be interest-only.

Listen to the podcast: CPA Changemakers: a discussion on housing affordability

Taken together these measures, says Wargent, were “pretty unique” – and effective.

Within a few months of the investor loan cap, borrowing slumped, dropping by almost a third through 2015, and it has continued to decline.

By April this year investors accounted for just 42 per cent of home loans, the lowest proportion since 2012, and growth in investor lending had dropped below 5 per cent, down from a high above 10 per cent.

Interest-only borrowing, too, has wilted. It accounted for more than 40 per cent of loans approved in 2015; by early this year the ratio was less than 20 per cent.

The regulation-driven credit squeeze has dampened housing markets. Auction clearance rates have slumped to less than 57 per cent nationwide, and are the lowest they have been since 2012, according to CoreLogic figures.

APRA released the brakes on investor lending in April but has no intention of relaxing the pressure on lenders, demanding they limit new lending at very high debt-to-income levels, and set debt-to-income levels for borrowers.

Australia: headed for a property crash?

However, the risks already built up in the system are not going away in a hurry.

The Organisation for Economic Cooperation and Development (OECD) has flagged household indebtedness as the economy’s biggest risk. The ratio of total household debt to income has jumped almost 30 percentage points in the past five years to reach 189 per cent in December 2018, and mortgage debt alone was 139 per cent of income.

Although wealth has grown even faster, some who have borrowed heavily may be vulnerable.

University of New South Wales Business School Professor of Economics Richard Holden puts the chances of a house price crash at 30 per cent, most probably triggered by widespread defaults on interest-only loans.

Although Holden says it is most likely that the property market will avoid a collapse, the risks created by more than A$100 billion of interest-only loans are “non-trivial” and cannot be ignored.

The Reserve Bank of Australia (RBA) estimates that each year until 2021, about A$120 billion of such mortgages will convert to traditional principal and interest loans, forcing up repayments by between 30 and 40 per cent.

The RBA thinks most households have enough of a financial buffer to absorb the increase. However, Holden warns that if even just 10 per cent struggle to make their repayments and are forced to sell, that could be sufficient to trigger a crash.

“I’m not really worried about what happens in Point Piper, Double Bay or Toorak,” he says. “I’m worried about what could happen in the western suburbs of Sydney and Melbourne. If there are big forced sales there, then great damage is going to happen to people who can afford it least.”

Professional Development: CPA Q&A. Access a handpicked selection of resources each month and complete a short monthly assessment to earn CPD hours. Exclusively available to CPA Australia members.

Interest rates: the price of money

A sudden jump in interest rates is another risk.

Few expect the official cash rate to budge from its current record low of 1.5 per cent before late 2019 at the earliest.

However, this doesn’t mean borrowers won’t feel some financial pinch.

Wholesale funding costs on international markets are increasing, and already some smaller lenders are responding by pushing up interest rates on selected mortgages.

Lenders including Macquarie, the Bank of Queensland and Auswide Bank have increased rates on variable interest mortgages by an average of between 0.08 per cent and 0.27 per cent, and Lawless expects larger banks will eventually have to follow suit.

Still some life left in the market

Even if the country avoids a default-induced property crash, economists expect that tighter credit standards and the chilling effect of the banking Royal Commission on lenders will force house prices down for some time yet.

Fifteen economists polled by comparison website Finder.com.au tipped that prices in Sydney and Brisbane could drop by as much as 6 per cent by the end of the year, 4 per cent in Melbourne and Hobart, and 2 per cent in Perth, Adelaide and Darwin.

ANZ Banking Group is even more bearish. It predicts prices nationally could fall by 6 per cent from September 2017’s peak to a trough in 2019, including a plunge of up to 10 per cent in Sydney – a view shared by Macquarie Securities. AMP Capital warns they could drop by as much as 15 per cent by 2020.

However, Australia’s status as a destination of choice for migrants may limit the extent of any decline.

The country, particularly its biggest cities Sydney and Melbourne, has been a magnet for immigrants and Australia’s population is growing close to the fastest among developed countries.

Professor Holden says it is on track to expand by 1.6 per cent this year, and all these people have to live somewhere.

With the supply of dwellings set to tighten – building and home loan approvals nationally have both dipped recently – pressure on home prices could again build.

Australia’s seemingly tireless property market might have more life in it yet.

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Australian politics is not broken, but the Liberal Party might be

The Liberal Party’s extraordinary leadership turmoil, and the likelihood that yet another  Prime Minister is cut down before serving out their full term, has many wondering if the political system is broken.

It isn’t.

There is no doubt that the slavish attention now paid to opinion polls, which have assumed oracular status, has made party politics highly volatile, and the position of leaders more precarious.
But what is playing out in gory detail before the eyes of the country at the moment isn’t the breakdown of political machinery, but a fight for the soul of the Liberal Party.
Abbott, Dutton and co. hold the delusion that they are representative of a mythical ‘silent majority’ that ascribes to their vision of a white-bred country. In their world, Turnbull has too much in common with the Left and is leading the country to Gomorrah and the Coalition to oblivion.
There is no doubt that many people, probably the majority, are not particularly thrilled about the current state of affairs. No period is without its challenges, but the sense of uncertainty and apprehension about the future appears heightened at the moment.
Yet relatively few, I suspect, think that the solution is just to shut the eyes and pretend none of it is happening, which is essentially the policy prescription of Abbott and Dutton.
Which brings us to today’s tussle over where the Liberal Party sits, and where it is going.
For years the Coalition has been slowly abandoning the political centre, something the wiser heads in Labor have spied and are trying to exploit.
The politics of migration to one side (bipartisanship on the treatment of refugees has largely neutralised the issue), the Coalition has sought to wind back action on carbon emissions, undermine Medicare, derail public education reforms, narrow Australia’s engagement with the world, drag the feet on child care and pander to the interests of older voters over those of the young.
Turnbull, who was chosen by his colleagues to replace Abbott and stem this rightward drift, has proved himself an inept politician. By pandering to the maddies like Abbott and Christensen rather than staring them down, he undercut his own authority and emboldened them. The dynamic this set in train was always going to end up in tears.
A Liberal split?
The compulsory voting system means that the weight of the national vote is in the centre – only on rare occasions, and in particular electorates, do the extremes gain much traction. Howard understood this. So did Keating, hence his success in beating Hewson by painting him as an economic ideologue and a risk.
If Abbott, Dutton and co. seize the leadership today and try to drag the Coalition even more to the right, they will increase the strain on a party whose unity is already under severe pressure from trying to span such a wide political spectrum.
An outcome of this episode is that the Liberal Party could splinter. In the early 70s, the success of Whitlam-led Labor revealed a shift in the nation’s political centre over the previous decade or so that had been disguised by the dominance of Menzies and the Liberal Party. As the Coalition recalibrated its position, Don Chipp spied a gap in the political centre and formed the Democrats.
If Abbott and co prevail today, some current Coalition MPs may take a leaf out of the same playbook and quit. The Liberal Party could become a rump based in regional Queensland and parts of WA and NSW.
If Bishop ends up succeeding Turnbull, as I suspect is more likely, it would signal that the bulk of Liberal MPs understand that their political future lies in a contest for the centre.
Abbott, Dutton, Christensen and their fellow travellers would then face the stark choice of sucking it up, or finally having the gumption to leave the supportive cocoon of the Coalition and putting the extent of the their electoral appeal to a real test by forming their own party.
My guess is some might follow Bernardi and do the crazy-brave thing, but most are too timid (and smart) and will stay put, because in their heart of hearts they know that their political relevance is likely to be much reduced once they step outside the shelter of the Liberal Party.
If anything, this episode will show the strength of our political system and, in particular, the virtue of compulsory voting.

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Why we should be worried about what happens to Turnbull

By Adrian Rollins

Now that the Band-aid has been ripped off the Coalition’s torn leadership, what does this portend for the nation’s economy?

Among the many self-inflicted wounds of Malcolm Turnbull’s trouble-plagued prime ministership, his dogged pursuit of business tax cuts stands out.

Turnbull expended substantial political capital and effort on the measure, lambasting opponents like the Labor Party and badgering waverers like Pauline Hanson’s One Nation. Despite setback after setback, the Liberal leader did not waver from his support for the policy, which he said was essential to sustain the country’s economic competitiveness.

In the end, it was all for nought. Though tax cuts for businesses with a turnover of less than $50 million have been passed into law, a Bill to provide similar relief for larger firms has today been rejected by the Senate.

Turnbull’s signature economic reform of the past year is dead.

It caps a terrible record of under-achievement for a Prime Minister whose CV sparkled with private sector success as a lawyer, a banker and an investor.

After a string of career politicians leading the country, (Keating, Howard, Rudd, Gillard, Rudd (again), and Abbott), Turnbull was seen as a welcome break – holding out the promise of a practical and results-driven politician just keen to ‘get things done’.

Instead, it is Turnbull who got ‘done’. The rot set in in the earliest stages of his leadership when he caved to the demands of haters and extremists on the Right, rather than staring them down. Having just won the endorsement of his Liberal colleagues by a convincing majority, his political power was at its zenith and the likes of George Christensen, Corey Bernardi, Jim Molan and Craig Kelly could have been marginalised.

Instead, by pandering to their ever-more-strident demands, Turnbull fed the beast of dissent, and is now set to pay the ultimate price.

Having failed miserably to deliver the tax cuts he argues the country needs, and having failed to erase the fog of uncertainty shrouding the nation’s energy and climate change polices, Turnbull’s economic legacy is exceptional only in its mediocrity.

But if you think that’s bad, his potential replacement could well be even worse.

Peter Dutton, a man who rose without trace after being plucked from backbench obscurity by an increasingly embattled John Howard as a sort of electoral talisman, is not a deep thinker.

That by itself is not necessarily a deal-breaker when it comes to being PM, but its opposite should be.

Throughout his career, Dutton has shown himself to be a narrow and unimaginative politician. He has adhered like araldite to a constellation of received attitudes and prejudices that hark back to an Australia that has long since departed from most corners of the country.

Think this is harsh? Consider his response when asked on Sky TV, in the aftermath of his failed leadership bid, what he thinks of the Coalition’s prospects: “I believe strongly that we can win the election if we get the policies and the message right about lowering electricity prices, about … We need to invest record amounts into health and education, aged care and …”.

It’s a shopping list of platitudes, not a manifesto for leadership. Dutton might say he is merely reciting the priorities of the Government of which he remains a member.

But for someone who has long harboured ambitions to reach the top job, it seems like a very thin resume of ideas.

Aside from a determination to ignore the policy challenges of a rapidly changing climate, Dutton’s grab bag of priorities betrays sloppy economic and fiscal thinking.

First the fiscal. Just by virtue of holding its spending steady as a proportion of GDP, governments each year invest “record amounts” in areas like health, education and aged care.

Economic naivety could be much more serious and potentially damaging.

If, by “lowering electricity prices”, Dutton is simply using shorthand to refer to policies that might help contain the extent of price rises, that might not be so egregious. Governments already interfere in market pricing, such as by limiting annual residential rent increases. While this distorts the property market, the potential discouragement of investors is balanced against the financial certainty it provides to renters.

But if he is delving into the agrarian socialist playbook of his fellow-travellers in the National Party like Christensen and Barnaby Joyce to introduce price controls, that is much more concerning.

Because of the modest size of its economy, Australia relies heavily on foreign investment for development.

But every measure taken to prop up farmers and rural industries, to block offshore investors, and to control prices, comes with a cost.

In the aftermath of the GFC, Australia has been a popular destination for foreign investors. But as the US and other economies strengthen, that advantage is waning.

Markets hate uncertainty, so the latest bout of instability surrounding Australia’s highest political office is unhelpful.

Add to that the prospect of a change to a leader even more deeply beholden to vested interests and a Trumpian understanding of the economy and trade (ie. not much), and even the modest growth of recent times might seem like a golden time of prosperity and stability.

As Coalition MPs consider how they will vote in the next leadership ballot, let’s hope they consider what’s best for the country, rather than just what’s best for them.

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The Europeans get a jump on the Poms

WHILE the Brits turn themselves inside-out trying to work out if they should go for a hard, soft or slightly runny Brexit, the EU is keeping its trade negotiation machine running at high gear.

In recent years the Europeans have been busy stitching together a web of regional and bilateral trade deals that span the globe. Of the 164 countries that are members of the World Trade Organisation, just six do not have preferential access to the EU.

Currently, Australia is one of them. But that could soon change after the European Parliament on 26 October authorised the EU to begin talks on a Europe-Australia Free Trade Agreement (FTA).

This authorisation comes at the end of a long process of sounding each other out and assessing whether such a deal is desirable and worth the effort, so it is a big deal.

It means that a Europe-Australia FTA of some kind is virtually inevitable.

Politically, this is soc in the eye for Theresa May’s Government.

One of the conceits of Brexiteers is that, freed from the shackles of the EU, Britain may once again rise to global eminence as a champion of free trade. Some even hope that the Commonwealth can be transformed into a sort of ‘Empire 2.0’. In their imaginings they hope/believe that former colonies like Australia, New Zealand, Canada and India will fall over themselves at the opportunity to resume the trade links that were severed or downgraded when Britain joined the Common Market in the early 1970s.

Put aside the fact that the days of Empire are remembered far from fondly in much of the Commonwealth, the idea has little grounding in the economic reality of today.

In the days of Empire, Britain was a major manufacturer with a huge appetite for raw materials it was an obvious market for commodities produced by its colonies.

But after 40 years of integration with the EU, the British economy is vastly different. Most of its manufactures are intermediate goods that are part of supply chains that crisscross Europe like a web, and services like finance, education and tourism support much of its wealth.

Meanwhile, the former colonies have well and truly moved on.

Canada is closely dies in economically with its giant US neighbour, Australia and New Zealand look much more to China and Asia for their markets, India is developing into a major economic power in its own right and the former African colonies have more extensive trade arrangements with Europe than Britain.

Europe, the land of opportunity?

It is fair to ask whether Australia needs a trade deal with Europe, given that the EU is already our third largest trading partner (bilateral trade was worth A$68.7 billion in 2015), and a major source of foreign investment (worth A$220.3 billion in 2015).

But there are frictions in the trade relationship.

European agricultural markets such as beef, sugar, dairy and cereals remain heavily protected from Australian exports, contributing to a lopsided trade flow.

In 2015, the EU sold almost A$30 billion more of goods and services to us than we did to them.

The question is whether the Europeans will be able to offer better access to their markets for Australian farmers.

In its statement on the negotiating mandate, the EU has stressed that “the European agricultural sector and certain agricultural products, such as beef, lamb, dairy products, cereals and sugar…are particularly sensitive issues in these negotiations”.

Given that Australia is the world’s third largest beef and sugar producer, and is a major player on global cereal and dairy product markets, Europe’s notoriously bolshie farmers are unlikely to meekly accept increased market access for their Australian competitors without a fight.

The EU trading mandate also calls for meaningful commitments from both parties to protect fisheries against illegal and unregulated fishing, which is significant given concerns about the rapacious fishing practices of fishing fleets operating out of Spain, France and other EU countries.

It appears this might be a fight the EU does not have the stomach for in the current fractious political climate prevailing in Europe, where populist and nationalist movements command significant electoral support.

In careful language, the EU negotiating mandate stipulates that a “balanced and ambitious outcome” on agriculture and fisheries is only feasible if it “gives due consideration to the interests of all European producers and consumers”.

Tellingly, this “consideration” includes the possibility of tariff-rate quotas or unspecified “transition periods”, and even holds out the possibility of so-called safeguard clauses to allow preferences to be suspended temporarily, or even excluding the most sensitive sectors (beef, sugar, cereals, dairy) from negotiations altogether.

Australian negotiators might talk tough if the EU tried to block improved access for farm products altogether, but the Europeans would remember how Australia caved to the US when it refused to include sugar as part of the Australia-US Free Trade Agreement.

Whatever happens on agriculture, the EU wants the FTA with Australia to include “significant concessions on public procurement at all levels of government, including state-owned enterprises”, and is also looking for commitments on anti-dumping and countervailing measures that go beyond WTO rules.

Other provisions the EU is seeking include:

  • a “robust and ambitious” chapter on sustainable development;
  • a requirement to promote corporate social responsibility;
  • comprehensive provision to liberalise investment; and
  • strong and enforceable intellectual property protections.

Brexit dangles like an unanswered question over the Australia-EU trade talks.

The final terms of Britain’s exit from the EU will resound globally. But by pushing ahead with its trade negotiation agenda, the EU is staying faithful to its ambition as the world’s foremost transnational economic community.

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Will cutting company taxes really pay off?

[This is a copy of a story I wrote that has been published in the August edition of In The Black. The story as it appeared in the magazine can be found here: https://www.intheblack.com/articles/2017/08/01/cutting-company-taxes]

Cutting taxes is an expensive business, so it seems odd that debt-laden governments are rushing to lower corporate tax rates.

A budget deficit of US$588 billion has not deterred Donald Trump from announcing plans to slash America’s nominal corporate income tax rate from 35 to 15 per cent[1] at an estimated cost of US$190 billion[2]. Despite uncertainty about the long-term economic impact of Brexit, the United Kingdom has just reduced its corporate profits tax to 19 per cent, and will lower it to 17 per cent in 2020.

In Australia, the Turnbull government has secured support for a phased reduction in its company tax rate from 30 to 27.5 per cent for businesses with a turnover of up to $A50 million at a cost of $29.8 billion[3], and eventually wants an across-the-board rate of 25 per cent, which in total will cost $65.4 billion in foregone revenue[4] – this at a time when the deficit sits above 2 per cent of GDP and no surplus is in prospect until at least 2020-21. Even Hong Kong, which has lower company tax rates than most, is feeling the pressure to continue cutting, announcing that 75 per cent of its 16.5 per cent profits tax will be waived up to a ceiling of $HK20,000[5].

These governments, and others like them, are betting that the benefits expected to flow from cutting company taxes – increased investment, improved productivity, higher wages and a bigger economy – will eventually overshadow the short-term cost to both taxpayers and government coffers.

In this, they can expect some assistance from improving international conditions. The International Monetary Fund reckons the global economy is finally gaining momentum and will expand by 3.5 percent this year and 3.6 percent in 2018[6], with indicators for investment, production and trade all pointing up.

But much rests on how investors, particularly those from offshore, will respond.

Can less be more?

Foreign investment has long been the lifeblood of growth for Australia – current account deficits have for decades been a permanent feature of the economy[7].

The Australian Government expects that cutting the corporate tax rate will attract more international capital to the country, spurring investment in technology, equipment and skills and generating more jobs and higher incomes.

Modelling and analysis by economists such as former Treasury Secretary Ken Henry suggests they are right.

In 2009, Henry recommended a cut in the company tax to 25 per cent on the grounds that “reducing taxes on investment, particularly company income tax, would…encourage innovation and entrepreneurial activity…[and] increase income by building a larger and more productive capital stock, and by generating technology and knowledge spill-overs that boost the productivity of Australian businesses”[8].

Treasury officials have put some numbers on the likely benefit, estimating that a cut in the company tax rate to 25 per cent would deliver a permanent 0.6 to 0.8 percentage point lift in real gross national income, underpinned by an increase in investment of almost 3 per cent, a 0.4 per cent boost to employment and a 1.2 per cent rise in before-tax wages[9].

The tax changes agreed to so far by Australia’s Parliament fall well short of this lofty goal but the Government is undeterred, and has introduced legislation seeking approval for a cut to 25 per cent.

Observers like Melbourne University professor of economics John Freebairn and Jim Minifie, Productivity Growth Program Director at the Grattan Institute think-tank, think Government policy is right to push for corporate tax cuts.

“If we were to reduce our corporate tax rate, that would reduce the tax burden on non-resident investors, so they pour a little more money into Australia,” Freebairn says. “That means slightly better, more sophisticated machinery and equipment, they might bring some extra technology and managerial expertise with their investment and, with people working with better machinery and technology, their productivity goes up and that pushes them into higher wages.

“That is the story in the Henry Review, and that has been backed up by modelling by Treasury and the Centre for Policy Studies.”

Minifie calculates that the Government’s eventual goal of an across-the-board reduction to 25 per cent could deliver a 15 per cent rate of return over 10 years – “not bad for a government that can borrow at 3 per cent”.

Freebairn is more cautious about estimating the long-term benefit of such a tax cut.

“Whether Australia in general wins or loses depends on how much bigger the Australian economy grows as a result of the extra investment,” he says. “Treasury modelling is saying you are going to recoup about half of it, but it could quite easily be 20 or 30 per cent plus or minus that.”

A hard sell

It is no surprise that governments are keen to talk up the potential for wages to rise on the back of corporate tax cuts, and to claim that they will effectively pay for themselves in stronger economic growth.

The idea that investors, many of them foreign, should get a hefty tax break in return for uncertain and delayed gains would be a hard sell at any time, but particularly so when budgets are constrained and wages are stagnant.

The Trump administration, which will have to win congressional approval for its tax plan, argues that the massive cost of its proposed corporate tax cut will be covered by a sustained increase in economic activity.

Though the claim has been dismissed as “fanciful” by The Economist[10], the cut is part of a package of reforms that in aggregate could boost US corporate tax collections.

America’s labyrinthine tax laws are riddled with loopholes and exemptions that mean the effective tax rate is more like 20 to 25 per cent, well below the nominal 35 per cent rate. The system is further distorted by arcane rules that discourage companies from repatriating profits (it is estimated they have up to US$2.5 trillion stashed abroad[11]) and encourage them to adopt exotic legal structures and take on debt rather than raise equity.

US Treasury Secretary Steve Mnuchin wants to reform the system, including allowing company profits to be taxed by the country where they are earned and offering a one-off tax rate (rumoured to be set at 10 per cent[12]) on repatriated profits[13] in order to lure much of this money back home. Some estimate the change could tip an extra US$250 billion into federal government coffers[14].

Unfortunately for the Australian Government, it does not have a similar pot of potential revenue to draw upon to help pay for its corporate tax cuts.

Instead, it is banking on increased domestic growth, a stronger global economy and extra taxes and charges on income earners, banks and employers to help offset the cost and put its finances on a path to recovery.

But a soft employment market and slowing wage growth has forced the Australian government to downgrade its anticipated tax take from workers and shoppers. It has trimmed $6.3 billion from its four-year forecast for individual and other withholding tax revenue in its 2017-18 budget, and expects to receive $2.5 billion less from the goods and services tax than it originally thought[15].

Instead, it predicts in the short-term that corporate tax revenue will pick up on the back of stronger global commodity prices, tipping an extra $6.9 billion into its coffers, while a 0.5 percentage increase in the Medicare levy combined with a levy on the major banks and a charge on businesses employing foreign skilled workers it expected to raise an extra $14.9 billion over four years.

This, in tandem with a swathe of cuts to higher education spending, welfare payments and price cuts for subsidised medicines, is expected to help drive a return to budget surplus in 2020-21, even accounting for the cut in the corporate tax rate to 27.5 per cent.

Some, such as CPA Australia chief executive Alex Malley, have questioned the Government’s forecast for GDP growth to accelerate to 3 per cent by 2018-19[16], and ANZ Banking Group economist David Plank says that although the budget’s numbers looked plausible, they were “at the optimistic end of what is likely to happen”.

Malley worries that the country is riding its luck on improved international conditions rather than undertaking the difficult reforms that are needed.

“We’re concerned we may be falling back on our ‘lucky country’ mentality and hoping that world growth will be sufficient to see us through,” Malley says. “There are still underlying structural issues in our economy that have not been effectively addressed in this budget.”

He says the government is over-reliant on individual and company income tax revenue, and will eventually have to confront difficult choices regarding the nation’s tax mix.

If the global economy falters again, or corporate tax cuts fail to deliver on hopes for an increase in investment, productivity and wages, that moment may come sooner than it expects.

 

 

 

 

[1] https://www.theatlantic.com/business/archive/2017/01/trump-corporate-tax-cut/514148/; “Cutting the tangle”, The Economist, 29 April, pp50-1.

[2] The Economist estimates the tax cut would cost about 1 per cent of GDP: “Cutting the tangle”, The Economist, 29 April, pp51.

 

[3] http://thenewdaily.com.au/money/news-federal-budget/2017/05/11/budget-2017-scott-morrison-tax/

[4] http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;db=CHAMBER;id=chamber%2Fhansardr%2Fd376893a-a137-4f4f-8358-337edb90aa4b%2F0125;query=Id%3A%22chamber%2Fhansardr%2Fd376893a-a137-4f4f-8358-337edb90aa4b%2F0000%22

[5] http://www.ird.gov.hk/eng/tax/budget.htm#a01; http://www.gov.hk/en/residents/taxes/taxfiling/taxrates/profitsrates.htm

[6] http://www.imf.org/en/Publications/WEO/Issues/2017/04/04/world-economic-outlook-april-2017

[7] https://knoema.com/search?query=current+account+balance+australia&pageIndex=&scope=&term=&correct=&source=Header

[8] https://taxreview.treasury.gov.au/content/downloads/final_report_part_1/08_AFTS_final_report_chapter_05.pdf, p40

[9] http://www.treasury.gov.au/~/media/Treasury/Publications%20and%20Media/Publications/2016/TWP2/Downloads/PDF/Treasury-Working-Paper-2016-02.ashx

[10] “Under audit”, The Economist, April 29, p8.

 

[11] https://www.minnpost.com/politics-policy/2017/05/trump-s-tax-plan-seeks-bring-back-trillions-corporate-profits-held-abroad-ca

[12] https://www.bloomberg.com/news/articles/2014-04-17/u-dot-s-dot-states-target-corporate-tax-shelters-overseas

[13] http://edition.cnn.com/2017/04/26/politics/white-house-donald-trump-tax-proposal/

[14] https://www.minnpost.com/politics-policy/2017/05/trump-s-tax-plan-seeks-bring-back-trillions-corporate-profits-held-abroad-ca

[15] http://budget.gov.au/2017-18/content/bp1/download/bp1_bs5.pdf

[16] https://www.cpaaustralia.com.au/about-us/leadership-and-influence/budget

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Trump’s world

At least holidays to the US will be cheap for a while.

It is hard to know where to start with a Trump presidency.

Will he really rip up NAFTA, start building a wall on the Mexican border, toss out ‘illegals’ and block Muslim immigrants?

Or will wiser heads prevail once he grabs the reins of power and the full implications of his various outrageous and incoherent policy announcements become apparent?

The terrifying thing is that no-one knows.

Who knows how a bullying, narcissistic and misogynistic demagogue is going to behave in the White House.

But if he lives up to even a bit of his rhetoric, both the US and the world are in form some very ugly times.

Here’s just a sampling of the changes a Trump presidency may usher in, and how they would affect the world, and Australia.

In line with his much less internationalist view of America’s role, Trump is likely to oversee a reversal of Obama’s pivot to Asia.

Asia Pacific allies like Australia, Japan, South Korea, the Philippines and Thailand will be left to do more of the heavy lifting in regarding regional security. Some might be tempted to move closer to China.

China itself faces great uncertainty.

Trump has indicated he wants to throw up the tariff barriers to Chinese imports. It is a move that will not only impoverish many who voted for him in the first place, by denying them access to the cheap goods that have softened the impact of stagnant wage, but could be very destabilising for the Chinese Government.

Though China has been trying to engineer a change in the economy toward consumption-driven growth, it is still a work in progress, and much of its prosperity is still tied to exports. If Trump was to pull up the shutters on China’s biggest market, the consequences would be dire – not just for China, but also Australia, which depends on Chinese demand for much of its export sales.

If Trump sparks a trade war of the kind that preceded World War Two, when trade barriers went up around the world, the political and economic damage will be huge. The post-war world order that has driven unprecedented prosperity – billions propelled from poverty, disease and malnutrition abating – could be shattered. We would all be the much poorer for it.

The fissures within the US itself that have been exposed by the hate-filled campaign of the last 12 months may widen, instead of narrow, particularly as the fortunes of the have-nots deteriorate further.

Then there is the worry that comes with a nuclear arsenal capable of killing us all many times over being in the hands of one that seems so volatile and unstable.

It is a grim outlook.

But there are at least two threads of hope.

One is that this becomes the high water mark for the craziness that has gripped the world this year. The so-called anti-establishment crowd (who seem very disparate except, maybe to themselves) have had their Brexit, and they have populated the Australian Senate with fringe-dwelling nutters.

But under the pressure of actually trying to do something, and reconciling interests that are increasingly at odds, the coalitions of resentment and anger that have propelled such outcomes may evaporate, and the promises of better times that they sold will be seen as the flimsy soundbites they were.

The second hope is that Europe will cleave to its moderate sensible course and thrive as smart money exits the US and China sees it as an increasingly attractive place for investment.

It may become a salutary lesson for the naysayers in the US and Britain of what they gave up for their collective fit of pique.

In the meantime, can someone please keep Trump away from that button!

 

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