Like most myths, this has a little bit of truth to it.

While references to ‘tripling the tax-free threshold’ are technically correct,  the effective threshold (taking into account the LITO) is only going from $16 000 to $20 542. However, while that might sound less impressive and is certainly harder to convey in a sound bite, the increase in the tax-free threshold will still deliver a significant tax cut to low-income earners.

In fact, the new tax scales will take the effective tax-free threshold to its highest level on record (the ATO historical tables only go back to 1983, frustratingly).

 Effective tax-free threshold since 1983-84, in constant 2011 dollars

Not only will the real effective threshold be higher than ever, but the 2012 change represents the largest single-year increase in the effective threshold. The second largest increase came with Wayne Swan’s first budget, in 2008-09.

Change in real effective tax-free threshold on previous year 

Even if the effective threshold wasn’t changing at all – if the rise in the statutory threshold was just replacing the LITO – this would still be a positive reform in a lot of ways. A higher statutory tax-free threshold means more money in the pockets of low-income earners each week, rather than the LITO system which means that they have to wait until tax time to receive half of the LITO benefit.

In short, the change in the tax scales will deliver a meaningful benefit to those on low incomes.

Note: Effective TFT = statutory TFT + (LITO amount/lowest MTR).

It’s important to understand exactly what we buy with that 16% of GDP. When a politician talks vaguely about “middle class welfare” and a culture of entitlement, a lot of voters probably nod sagely and think of their least favourite porky perk for other people, like the baby bonus. The problem is that that isn’t where most of the money goes. Most of our social spending, nearly two thirds of it in fact, goes to health and old age assistance (which consists mainly of the aged pension).

Here’s where our public social spending goes:

Public social spending as a proportion of GDP in Australia

Source: OECD Social Expenditure Database 

Hockey could eliminate all social spending other than health and old age assistance and we’d still be at 10.1% of GDP, well above Korea, a country he mentions as a benchmark. In other words, even if we scrapped all help for people with disabilities (the support pension as well as in-kind help), got rid of Newstart, stopped spending anything on helping people find work, and eliminated all housing assistance, we’d still be devoting more than our Asian neighbours to social spending.  That leaves health care and old age pensions as the only place left to cut to get down to the sort of levels that Hockey identified. The safety net as we know it would be a thing of the past after cuts of that size.

The next question that arises from Hockey’s speech is whether Korea and Hong Kong are really the right countries to which we should compare ourselves. If we compare Australia to the other OECD advanced economies, it’s clear that our social spending is quite low, lower even than the United States (as a proportion of GDP).

Public social spending as a proportion of GDP in the OECD countries

Source: OECD Social Expenditure Database 

A lot of people might be surprised by the fact that Australian public social spending is lower than America’s and lower than most advanced economies. Compared to America, we spend less on health (although we have longer life expectancy), and less on aged pensions (because ours is more tightly means tested).

The composition of social spending in Australia and the US

Source: OECD Social Expenditure Database 

Means testing is a big part of the reason that our social spending is so low relative to most advanced economies. We means test our payments more than any other OECD country, which means we achieve more poverty alleviation and inequality reduction per dollar spent than anywhere else. As Professor Peter Whiteford has repeatedly pointed out, “Australia actually has the lowest middle or upper class welfare in the OECD”. Professor Whiteford was good enough to send me the chart below, which shows the share of transfer payments received by the richest 50% of the working-age population, ie. middle-to-upper class welfare. The English-speaking OECD countries are in red, with Australia right at the bottom (click the chart if you want to make it bigger).

Middle class welfare in Australia has increased a little bit over the past thirty years, but most of that increase has been for lower-to-middle income families. Relatively little welfare spending (ie. transfer payments) go to families in the top half of the income distribution, and a very small proportion goes to those at the top.

Middle- and upper-class welfare for working-age families in Australia since 1982

Source: Whiteford, Redmond and Adamson 2011, table 1.

This means that there isn’t a lot of ‘low hanging fruit’ if you want to make big cuts to public social spending in Australia. We don’t spend a lot on middle- or upper-class welfare. It would also be hard to make our benefits much stingier, particularly Newstart Allowance. The unemployment benefit is already notoriously low, as pointed out by the OECD and Judith Sloan, among many others. Our payments are so tightly means tested that we claw them back from people at a pretty rapid rate when they start working – this creates the dreaded high “effective marginal tax rates” that make it harder for low-income people to get ahead. Tightening the screws even further wouldn’t achieve much – as Professor Whiteford and his co-authors put it, “difficulties associated with tighter targeting of mean tested payments in an already tightly targeted system would achieve little in terms of increased efficiency and would likely cause considerable pain”.

Hockey’s task, of finding enough cuts in social spending to bring us down to Korean levels, is even harder when you consider that the Coalition has committed to support the National Disability Insurance Scheme. The Productivity Commission’s recommendation is for a scheme that would cost about 1% of GDP. Half of this would come from re-allocation of existing disability funding, but the other half would be new money. If the Coalition wants to increase spending on disability care and support by 0.5% of GDP, while also reducing overall social spending to Korean levels, the cuts in other areas would have to be even deeper.

To achieve the sort of cuts that Hockey has flagged, to bring our social spending into line with Korea and other countries in our region, would involve huge cuts to health spending, pensions, aged care and help for people with disabilities. Quite simply, that’s where the money goes. No amount of fiddling around the edges could come close to bringing our spending in line with our Asian neighbours (other than Japan, which spends more than we do).  Instead, doing so would require ending the Australian social safety net as we know it.

For that reason, I’ve been looking at this measure that I’ve spliced together from the Labour Force statistics: the number of hours worked in a given month, per working age person (everyone 15+). This is a bit like the employment-to-population ratio, but it uses hours rather than employed persons as the numerator.

The hours worked-to-population ratio

This chart tells us that there isn’t as much work to go around as there was before the GFC, but we’re doing better than we were in early 2009. The number of hours per person flattened out in 2011, dipped in January and has recovered some lost ground in March.

Berg argues that government regulation is to blame for the White Star Line’s decision to send the Titanic out to sea with too few life boats aboard. Specifically, he blames the mandated minimum number of life boats that large ships of the day were required to carry. The minimum was out-dated and didn’t scale up. Regulations required that ships in excess of 10 000 tonnes must carry a minimum of sixteen lifeboats, but there was no additional requirement for super-large ships.

The argument, if I understand it correctly, is that the shipowners (and, implicitly, the passengers) placed undue faith in the regulators, believing that they must be benevolent overseers whose judgement it wasn’t wise to question. As Berg puts it:

There was, simply, very little reason to question the Board of Trade’s wisdom about lifeboat requirements. Shipbuilders and operators thought the government was on top of it; that experts in the public service had rationally assessed the dangers of sea travel, and regulated accordingly. Otherwise why have the regulations at all?

So the argument is that the regulation wasn’t seen for what it was, a minimum number of lifeboats, but rather misinterpreted as a guideline for an appropriate number of lifeboats. If the Board of Trade was willing to let you set sail with sixteen lifeboats, why add a seventeenth?

His argument rests on the presumption that people will not take greater precautions than required by law. Is that really the case? The law requires that we wear seat belts in our cars, for example, but it doesn’t require that we have air bags. Most new cars nevertheless come equipped with air bags. Why, following Berg’s logic, don’t people accept the wise beneficence of regulators? Seat belts are required, but air bags are not; why, then, do car manufacturers sell cars equipped with air bags? Why do people pay a premium for those cars?

On Berg’s account, we should expect that the proportion of cars that have air bags would actually be higher without the seat belt rule. Unable to defer to the judgement of regulators, people would have to form their own judgements about the appropriate level of car safety. Is this really plausible? It’s not to me. When I look around, I don’t see people sticking to legal minima just because they’re there. If it makes sense to exceed a minimum requirement, people will generally do so. To believe otherwise is usually the preserve of people on the left of politics, who see a role for regulators when self-interest can’t be relied upon to generate an outcome that’s socially ideal.

In lieu of longer posts, I’m going to start posting some ‘charts of interest’, which are just things that have piqued my interest in some way. I won’t accompany them with a whole heap of description or analysis, but will just let them speak for themselves. I’ve been posting these on Twitter, but followers of the blog might’ve missed them.

—

First, the unemployment rate in New Zealand is higher than the rate in any Australian State or Territory (or at least it was in late 2011).

This is relevant to the debate sparked by the “Trans Tasman Review” into greater integration between the two countries. At least at the moment, the differences between NZ and Australia seem to be greater than the differences between the Australian States.

—

On a related note, the gap between the highest and lowest unemployment rates of the Australian States is smaller than it used to be, despite the multi-speed economy.

—

A recent Essential Report by EMC tried to find this out. They asked a sample of respondents what they perceive to be a middle income and what they regard as a sufficient income to qualify as well off or wealthy. They asked this question about both households and individuals. It turns out that Australians have quite a realistic sense of what constitutes a typical income in today’s Australia.

The median response to EMC’s question about how much income would define a household as ‘middle income’ was $94 000 per year. A gross income of $94 000 would have put a household at around the 64th percentile of the household income distribution in 2009-10, when the last ABS household income survey was conducted. Australians’ understanding of what qualifies as a middle income isn’t too far the mark.

The research showed that people regard $111 000 per year as enough to make you ‘well off’, while $159 000 makes you ‘wealthy’. This doesn’t quite square with reports that households on over $150 000 are doing it tough. $111 000 would put a household at around the 72nd percentile of the distribution, while a household on $159 000 per year would be earning more than about 87% of Australian households (again, using 2009-10 numbers).

People in the EMC poll thought that an individual who earns $66 000 a year was on a middle income. This figure is just below the average earnings of a full-time worker, a bit above the median for a full time worker. This is a little high for an estimate of the median individual income, but is definitely in the range of what would be considered as a middle income. The research suggested  that an income of $106 000 a year was enough to make an individual wealthy, in the eyes of their fellow Australians. Given that this is around 50% above the mean for a full-time worker, and not far off double the median, it seems reasonable to agree that such an income is relatively high.

The evidence is quite clear: reports which suggest that households in the top 10% or 20% of households are actually ‘typical’ don’t square with the facts, and they don’t square with Australians’ views about what qualifies as a middle income. It’s worth bearing this in mind as another federal budget looms.

[Note: ideally, such a survey would ask people to think about working age households, or households in which at least one person worked. Respondents would also be asked to define what they thought was a middle income for a particular household type - say a family with two adults and two children. This would enable us to compare their responses to the data on equivalised incomes.]

UPDATE: Someone from EMC has helpfully made contact with me to clarify one point about their survey – they did actually ask respondents to define ‘middle income’ (etc.) for a household of 2 parents and 2 children.

Now imagine that the Australian dollar appreciated by 10 per cent in the same year. Although Australian goods and services would be no more expensive for Australians, they would suddenly cost more for Americans and Brits who earned US dollars and pounds. Australia would have become a more expensive place for Americans to live, if they’re being paid in US dollars, but the cost of living for Australians would have stayed the same (setting aside the fact that imports actually would’ve become cheaper for Australians).

That seems to me like a fairly easy concept to understand. Apparently it’s not. I know it’s not because of the way that today’s Economist Intelligence Unit report on the Worldwide Cost of Living was reported.

The EIU report is intended to help “calculate cost-of-living allowances and build compensation packages for expatriates and business travellers”. It calculates the cost of living in various cities in a common currency, US dollars. This means that in my hypothetical example of a few paragraphs ago, the report would show the cost of living in Australia going up, because the AUD had appreciated. It would take more US dollars to achieve the same standard of living in Australia as it did before the appreciation.

Although the study is perfectly well designed for its intended purpose, it tells us very little about the cost of living for people who live and work in Australia and are paid in Australian dollars. The EIU is quite clear about this – the first subheading of the report is “Currency Swings Move Global Players”. It clearly states that its measure of the relative cost of living in various cities is more affected by changes in exchange rates than changes in domestic prices.

[For the purposes of the this report,] local inflation in mature markets always has far less influence on the relative cost of living than the  currency movements of the countries in question. This also explains the recent presence of Australian  cities like Sydney and Melbourne in the ten most expensive locations as last year saw the Australian  dollar pass parity with the US dollar from holding half that value a decade ago. 

Despite the report’s clarity about its purpose and methodology, Australian media outlets have reported that it finds that the cost of living for Australians has risen. It shows no such thing.

For example, The Australian reported:

The cost of living in Sydney, Australia, is close to 50 per cent higher than in New York, according to a new survey that illustrates the painful side effects for residents living through a once-in-a-century mining boom.

 …

The findings will ring true with many locals, who regularly complain of rising prices for everything from energy supplies to staples such as fruit and vegetables.

Of course, the report doesn’t say anything about the ‘painful side effects’ of the mining boom for Australian residents, because it isn’t designed to do so. This type of write-up was typical of many others that emerged this afternoon in various media outlets.

What strikes me as particularly strange is that all the media reports noted that the exchange rate was the main cause of the rising cost of living as measured by the EIU. They nevertheless focused on the apparent change in the cost of living for Australians. This doesn’t make much sense.

Either the journalists understood what the report was designed to do and they or their editors chose to put a slant on the story that misrepresented the facts, or the journalists were genuinely unaware of what the report sought to measure and its methodology in doing so. It’s disturbing either way.

To believe that Mr Calombaris would open his restaurants on Sundays only to have them run at a loss is to believe that he’s running some sort of altruistic quasi-charity, an impression he attempts to give by suggesting that he opens on Sundays for reasons of “tourism”. I don’t believe that a successful businessman like him would run at a loss out of the vague goodness of his heart. Alternatively, he might choose to run at a loss on Sundays in order to build brand loyalty and increase his custom on other days of the week; the total return to opening on Sundays would therefore presumably make it worth his while.

He claims that he “recently stumped up $45,000 for a pasta extruder for Mama Baba” but that labour costs are now threatening his ability to make a decent return on that investment. The obvious question is why he dropped $45k on a pasta extruder if he knew he wasn’t going to be able to use it at a profit. The current restaurant industry award has been in effect since 1 January 2010; he would’ve known full well at the time he made the investment what the minimum wages and penalty rates were in his industry.

Anyway, he also makes some assertions about minimum wages that are straight-up false. He says that waiters would have to be paid $40 per hour on Sundays. This isn’t true.

The highest minimum wage in the Restaurant Industry Award 2010 is for a Cook Grade 5, described in the award as as a:

chef de partie or equivalent who has completed an apprenticeship or has passed the appropriate trade test or who has the appropriate level of training in cooking.

To employ such a chef at the highest grade would cost Mr Calombaris $19.71 per hour for ordinary time, or $24.64/hour if the chef is a casual (and therefore not entitled to paid annual leave and sick leave). If they’re employed as a casual on a Sunday, they receive a minimum of $34.49 per hour. Calombaris claims that he has to pay his staff a 75% loading on Sundays, but this includes the 25% casual loading. Even a worker at the highest grade in the award would not be entitled to the $40/hour Sunday rate that Calombaris bemoans.

But Calombaris’ criticism is specifically directed towards the wages paid to waitstaff. Here he is even more off base. Waiters (‘food and beverage attendants’ in the language of the award) would typically be employed at Level 1, 2 or 3, depending on their skill, experience and range of duties. If they’re employed at level 3, their ordinary time minimum wage is $17.14, or $30 on a Sunday for a casual.

Minimum wages in the restaurant industry

Source: Restaurant Industry Award 2010

If Calombaris is paying any of his waitstaff $40/hour on Sundays he is paying at least 33% above the award. Good on him, but if he’s doing so then he can’t really claim that the award is the cause of his high labour costs.

Another of Calombaris’ claims is that Australian fine dining restaurants are more expensive than their overseas equivalents. He told The Power Index, as reported in Crikey, that:

I can eat at [UK three Michelin star restaurant] Fat Duck cheaper than I can at some fine dining restaurants in Australia. But I know why it’s like that … because of our labour laws.

This is a strange claim. The tasting menu at The Fat Duck is £180 per person (plus an ‘optional 12.5% service charge’). At the current exchange rate, that’s around $AU270, without the service charge. The best restaurant in Australia, Quay, charges $220 for its tasting menu. Mr Calombaris’ own flagship restaurant The Press Club, charges $135 for its somewhat ostentatiously titled ‘symposium degustation’ tasting menu.

Australian fine dining restaurants appear to be a fair bit cheaper than their overseas counterparts, if we use the Fat Duck as a yardstick (as Calombaris himself has done) and convert the prices using current exchange rates. A better way to compare the prices across countries is in terms of median wages – how much of a typical full time wage would a diner have to spend to purchase a tasting menu at each of these restaurants? Well, in the UK the median full time wage is £501. This means a typical full time worker would need to spend 36% of her pay packet to buy a tasting menu at the Fat Duck (without the service charge). The Australian median full-time wage is $1050 per week, so a tasting menu at Quay costs 21% of a typical pay packet. The Fat Duck is more expensive for English people (and also for us) than its counterparts in Australia. Of course, overseas restaurants seem a lot cheaper to Australians than they used to, but that’s due to the soaring exchange rate.

Stepping back from Calombaris, what about the restaurant industry more generally? It’s certainly true that a greater than average proportion of workers in restaurants are paid at the award (minimum) rate. 45% of workers in the accommodation and food services industry are award dependent, meaning they’re paid exactly according to the minimum conditions in the industry. Only 15.2% of workers across all industries are award dependent. This means that if a change to the award system really had made it less profitable to employ staff, we’d expect to see the impact of the change most severely in the accommodation and food services industry. If Mr Calombaris’ story was accurate and modern awards were strangling his industry, we’d expect to see the profitability of restaurants go down, and employment in food and beverage service go down. This hasn’t happened.

Profit to sales ratio in the Accommodation and Food Services industry

Source: ABS 5676.0, table 22

Gross operating profits in the industry represented 12% of total sales in the September 2011 quarter, the latest quarter for which the ABS has released data.This is a higher ratio than during most of the WorkChoices period. Since the Restaurant Industry Award came into effect on 1 January 2010, the profit to sales ratio in the industry has been around 10% to 12%, in line with its typical level for the past decade. If the modern award is damaging the industry, it’s not showing up here.

You’d think that if the modern award had made food and beverage workers too expensive to profitably employ, then employment in that industry would fall, or at least grow more slowly than total employment across all industries. That hasn’t happened. Since November 2009, the last quarter before the Restaurant Industry Award took effect, total employment in food and beverage services has risen by 4%. Employment across all industries has also risen by 4%. The Restaurant Industry Award doesn’t seem to be damaging employment in that industry. Note that the employment data let us get down to the industry sub-division level, rather than just the overall industry level like the profits data above.

Employment in the Food and Beverage Service industry sub-division and in all industries (Index)

Source: ABS 6291.0.55.003, table 6.

Employment fell a little in the highly cyclical restaurants sector in 2011, but total growth since the new award system came into place has been the same as for the economy as a whole. If you’re going to blame the modern award system for the industry’s sluggish employment performance in 2011 then you also have to credit it with the surge that began in mid-2010.

At this point some conservatives might claim that total employment growth has been sluggish since the modern awards came into effect, so the effect is spread across all industries and therefore doesn’t show up in a comparison like the one in the chart above. If that were the case, wouldn’t the employment growth slowdown still be more severe in food and beverage services, an industry with a high proportion of award-reliant workers? The story just doesn’t hold up.

George Calombaris would like to pay his staff less money. He is entitled to make his case, but I wish his claims were subjected to a bit more critical scrutiny.

These were my most viewed posts this year:

• What is the typical Australian’s income?
• Inequality and the top 1% in Australia
• The state of the labour market
• Why care about inequality?

Thank you for reading!

• From the mid-1980s to the late-2000s, the incomes of the top decile of Australian households grew by an average of 4.5% per year, by far the fastest income growth enjoyed by high income earners in any OECD country. The average annual growth for the top decile in OECD countries over the period was 1.9%.
• Low income Australians also saw relatively strong growth from the 80s to the 2000s, growing at an average of 3% per year. Interestingly, the only countries in which low income earners saw stronger gains were Portugal, Ireland, Greece and Spain.
• Overall inequality in Australia, measured by the Gini coefficient, is slightly higher than the OECD average, though I wouldn’t put too much stock in the small difference between us and the average.
• We achieve less of a reduction in inequality inequality via taxes and transfers than we did a decade ago.
• “Labour market trends have been a key driver of inequality in Australia.”
• The share of income going to the top 1% has roughly doubled since 1980 (which we already knew from Andrew Leigh’s work), while the taxes paid by high income earners have fallen.

I plan to post more detailed analysis when I’ve had a chance to read the full report.

The problem starts with the title of his post: “Eurozone v Australia: Why We Beat Them”. The idea seems to be that Europe’s woes and our comparative fiscal and economic strength means we have “won”. This is a mercantilist fallacy banished by Smith and Ricardo centuries ago. Europe’s weakness harms us. We would be better off if Europe’s economy was growing strongly. Countries do not compete with each other in this way; trade is not a zero-sum game.

The rest of the post amounts to an assertion that Australian governments are in good fiscal shape (with low a debt-to-GDP ratio and moderate bond yields) because our government occupies a small share of the economy, due to means-targeting of welfare. This is the story that conservatives are trying to tell about the sovereign debt crisis: that European countries tax & spend too much, and that the bond markets have finally stopped the party.

Carr suggests that our relatively low social spending “has made it possible for Australian State and Federal governments to pursue policies of debt retirement”. It’s a strange argument. The ability to pay down debt is obviously a function of both spending and taxes; if government spending accounted for 40% of the economy, but taxes accounted for 41%, there would be a budget surplus and the stock of debt would decline. If spending was tightly means tested, accounting for only 25% of GDP, but taxes were light and accounted for 24%, the budget would be in deficit and the stock of debt would grow.

If Carr’s explanation of the crisis were correct, we’d expect to see higher bond yields in countries with higher tax-to-GDP ratios. We don’t. Sweden’s taxes account for around 47% of its GDP, yet last time I checked it could borrow funds at 1.62%. Ireland has around the same tax-to-GDP ratio as Australia, yet the yield on its bonds is over 8%. The two charts below (the first with Greece, the second without) tell the tale. If Carr’s story was true – that the size of the public sector is the main cause of the Euro crisis – then we’d expect to see the dots in these charts sloping upwards from the bottom left to the top-right. In other words, the bigger the government (as a proportion of the economy), the bigger the bond yield.

Tax-to-GDP ratio and bond yields in OECD countries

Tax-to-GDP ratio and bond yields in OECD countries (excluding Greece)

The Carr story just isn’t there in the data.

What if we just look at social expenditure? The story is the same: there are high-spending countries that are in trouble (Italy, Portugal) and high-spending countries that aren’t in trouble (Denmark, Finland). There are low spending countries that are struggling (Ireland) and some that aren’t (Australia).

Public social expenditure and bond yields in the OECD

Public social expenditure and bond yields in the OECD (excluding Greece)

If we set aside the bond yields and just look at the stock of government debt, it’s difficult to find evidence for the story Carr’s trying to tell. Japan taxes at about the same level as us, but has far, far more debt. Norway taxes a lot more, but its debt ratio is also low. Italy’s tax ratio is about the same as Norway’s, but its stock of government debt is huge.

The European sovereign debt crisis is about a currency area that encompasses too many diverse regions, with too little fiscal integration and weak oversight. It’s about a central bank that is reluctant (or unable, depending on your point of view) to play the role of lender of last resort. In the case of Greece, yes, it’s about a government that spent too much, taxed too little, and fiddled its books to hide its deficit. But look at Ireland: it’s a low-tax, low-spending country that was held up as a paragon of fiscal virtue by conservatives before 2007. George Osborne declared Ireland to be “a shining example of the art of the possible in long-term economic policymaking.”

The crisis is not about the welfare state. I can’t understand Carr’s motivation in suggesting otherwise.

NOTE: The bond yields data are from Trading Economics. The other data are from OECD Stat. The countries included are the 27 OECD nations for which Trading Economics has information about bond yields. I’ve used the most recent OECD data available.

• The US and Canada have taken different approaches to defining their official poverty threshold in recent years. We’ve solved this problem by not having one.
• Nicholas Gruen has written about the need for more humility and open-mindedness from economists, following on from this paper which argues that economists should see themselves less as scientists and more as engineers.
• The UK can now borrow more cheaply than Germany, challenging some of the narratives that have surrounded the Euro crisis.
• Should Australia move to shore up bank funding in a more explicit way?
• It’s the first edition of the ACTU Wages Report! By me! With graphs!
• Did behavioural economics backfire on the Obama administration?
• Dean Baker has a free e-book out called The End of Loser Liberalism, which is worth a read. He argues that progressives “have accepted a framing where conservatives want market outcomes whereas liberals want the government to intervene to bring about outcomes that they consider fair”.
• Here’s a two part interview with Dean Baker about his book.
• Interesting presentation by Peter Whiteford on inequality and social support in Australia.
• Mike Konczal on how inequality got so bad in the US, and what can be done to fix it.
• The “anxiety of the forever renter” in The Atlantic.
• Why doesn’t Britain make things any more?

He goes through the data and finds that the big four are making returns on equity in the vicinity of 18-20 per cent, suggesting that “the profits of major banks in Australia were the highest in the world during 2010″. Rogers summarises:

In other words, while bank executives continue to talk about “challenging” conditions, the data suggests the opposite: bank returns are rising, and are nearing levels experienced in the later years of the boom.

We would clearly rather have profitable banks than unprofitable banks, but is it right that highly protected institutions are able to deliver circa 20 per cent returns? The risk associated with those returns is greatly reduced by the implicit and explicit taxpayer guarantees attached to our banks, making the profitability of Australian banks the business of all of us.

As Chris Joye put it,

[T]axpayers have effectively said that they will insure away the risk of bank failure… what do these actions tell us? They clearly illustrate that bank shareholders get the benefit of a raft of… protections that are not supplied to other private companies. Given taxpayers have revealed that they are willing to insure away much of the downside risk associated with catastrophic bank failure, these institutions have, by definition, significantly lower equity risk.

If the probability of loss associated with investing with the majors has declined care of these profound changes to our prudential system… the expected returns should also fall. 

Joye goes on to ask the crucial questions:

given their protected-species status, should the banks be subject to stricter regulatory constraints on what businesses they can and cannot operate? Should they just stick to their knitting and focus on savings and loans? Do they need to be stockbrokers, corporate financiers, investment bankers, proprietary traders, and bankers to businesses and home owners in, say, China?

Wandering around Singapore recently, I saw a double-decker bus covered in advertising for ANZ, and pondered similar questions.

For example, this quote from Stephen Matchett in today’s Oz [paywalled], regarding the slowdown in productivity growth, riled me enough that I couldn’t let it through to the keeper.

So what went wrong?

The ACTU says nothing, that productivity was always a con. The economy did not speed up because we rowed smarter but because we were lashed into rowing faster. We wage slaves slump exhausted over the economy’s oars now the economic trireme is drifting.

Well, that’s news to me. I don’t recall seeing any statements from the ACTU that suggested that productivity was “always a con”. In fact, the ACTU issued a discussion paper less than two weeks ago on this very topic and nothing in it could be taken as a claim that “productivity was always a con”.

Here are a couple of quotes:

Increasing productivity is, in the long run, the main way that societies can improve their material standards of living. Productivity growth is the main driver of real economic growth, with workforce participation and population changes playing much smaller roles. True productivity growth is in the interests of workers.

…

Productivity growth is a necessary component of any social-democratic agenda for improving the lives of working people. Unions support productivity growth, but it is important that the concept and its relationship to public policy are properly understood.

…

Over the long-run, the trend rate of growth in Australian labour productivity is around 2 per cent. Australia experienced a productivity slump in the mid-1980s, growing well below trend, and a surge in the mid-1990s. The rate of growth in productivity has been falling since that time.

So far, so reasonable, I’d like to hope. But calm analysis like that doesn’t fit the ‘unions are the enemies of productivity growth’ argument that Matchett was evidently keen to advance. The solution? Just make something up. Claim that “the ACTU says… that productivity was always a con”. I gather that Matchett’s column is supposed to be vaguely humorous, so a certain degree of latitude should be granted, but I don’t think that should extend to completely misrepresenting an organisation’s position on such an important and prominent issue.

Grace Collier, union official turned employer-side industrial relations consultant, had a column in yesterday’s edition of The Australian. I found it quite offensive. Here’s a snippet:

HAVING a union presence in your business is like having a bear in your lounge room.

 You may think you have a good relationship with it, but it is a wild animal and one day it may be big, strong and of a mind to tear down your walls and eat your children.

Eat your children? Really? Can you imagine a newspaper printing that sort of comment by a union official about an employer representative in an op-ed? Perhaps I’m being too hyper-literal, but I can’t imagine a similar comment being dismissed as mere analogy if the roles were reversed.

She then turned to attacking Fair Work Australia:

It is true industrial relations outcomes are determined less by what the rules are than who the umpire is and right now the union’s umpire is on the field…

The union’s umpire? Really?

The President of Fair Work Australia, Justice Giudice, was appointed as President of FWA’s predecessor, the Australian Industrial Relations Commission, on 17 September 1997. You may recall that the Howard Government was in office at the time. Peter Reith was Minister for Workplace Relations, a man not noted for his union sympathies. FWA has two Vice Presidents, both of whom were appointed to the AIRC by the Howard Government, one in 2002 and one in 2006. Some of the other Deputy Presidents and Commissioners have union backgrounds, but I hardly think this is an institution that deserves sneering dismissal as “the union’s umpire”.

Continuing the theme of dodgy factual claims, Collier adds:

Since 1992, governments have left the productivity agenda to industry partners to achieve and the outcomes have been pathetic.

Pathetic? Really? In the 1990s, our rate of labour productivity growth outpaced the US and the rest of the OECD. It was more than double the average rate recorded in the 1980s. In the 2000s, a decade in which the various incarnations of the Coalition’s Workplace Relations Act were in effect until 1 July 2009, our rate of productivity growth fell below that of the US, but remained above the rest of the OECD.

Average annual growth in labour productivity (percentage points)

[Source: Treasury 2009 using data from The Conference Board]

I examine the facts about industrial relations and productivity growth in greater detail in this new ACTU Working Australia paper, though facts don’t seem to play much of a role in this debate.

It’s important to bear in mind that Australia is not the US. Inequality here is lower than in the US, social mobility is much higher; the unemployment rate is much lower. Whereas real median wages in the US have stagnated for decades, we’ve seen fairly solid real income growth across the income distribution. I think  that Australians who are concerned about rising inequality should be aware of the facts, so as to avoid making overblown and unsubstantiated claims. It’s easy to dismiss people’s arguments if they’re based on a misunderstanding of the facts.

Below, I set out some facts about income inequality (as distinct from wealth inequality, which is quite a bit higher than income inequality in Australia and elsewhere).

The share of income going to the top 1% in Australia has doubled in the past 30 years or so. [fn1]

According to the ATO’s tax statistics, if you earned $248 192 or more in 2008-09, you were part of the top 1%. The average income for an individual in the top 1% of taxpayers was $554 185. The median income for that year was $45 200, so the average income for someone in the top 1% was more than 12 times the median.

Top 1% income share in Australia

This is a pattern common to many developed countries – a ‘great compression’ in the three decades or so following World War 2, and then a ‘great divergence’ beginning in the late 1970s or early 1980s.

Even though the pattern is the same, the extent of the compression and divergence has been quite different across countries. The US is the extreme example. At the end of WW2, their top 1% had about the same proportion of total income as Australia’s top 1%, but our great compression was more pronounced and lasted longer than theirs. Our great divergence has also been less severe. Our top 1% has increased its share of income from around 5% to around 10% in the past 30 years, whereas the top 1% in America has increased its share from about 8% in 1981 to around 18% in 2007. Note that figures which include capital gains put the 1% share in the US closer to 25%.

Top 1% income share in Australia and the US

When you add in the other OECD countries, it looks like Australia’s top 1% income share is around the middle of the pack. It’s important to bear in mind here that these figures relate to pre-tax income; countries that have a similar pre-tax distribution but differing degrees of redistribution through the tax and transfer systems will end up with very different levels of inequality in net incomes.

Top 1% income share in OECD countries since WW2

It’s a bit hard to figure out which country is which in that tangle of coloured spaghetti, so the chart below shows the top 1% income share for selected OECD countries in 2005. I chose 2005 simply because that’s the most recent year for which the World Top Incomes Database has information for more than a handful of countries.  Again, this shows Australia as middle of the pack among developed nations for the share of gross income going to the top 1%. [UPDATE: A helpful reader pointed out that Norway's top 1% share spiked in 2005 due to tax changes in 2006, as can be seen in the chart above].

Top 1% income share in selected OECD countries in 2005

Of course, the top 1% income share is a very interesting piece of information, but it doesn’t tell us anything about the distribution of income among the rest of the 99% of the population. To get a more complete picture of income inequality, we need to use a measure like the 90:10 ratio or the Gini coefficient. A Gini of 0 implies perfect equality of incomes (everyone has the same income), whereas a Gini of 1 implies perfect inequality (one household has all the income). The closer a country is to a Gini of 1, the less equal its distribution. The data here are for net incomes, after taxes and transfers, and are based on household income, adjusted for household size. [fn2]

Measured using the Gini, our level of inequality (0.3) in the mid-2000s was slightly below the OECD average (0.31), but in a similar bracket to most European countries. Our level of inequality was below the level of most other English-speaking countries, and significantly below the United States (0.38). Although our income tax system has become less redistributive in the past decade or so, the tax and transfer systems as a whole still reduce inequality quite a bit in Australia.

Gini coefficient in OECD countries in the mid-2000s

Although inequality in Australia was middle-of-the-pack in the mid-2000s, the Gini in Australia has been drifting upwards. It rose from from around 0.29 in the mid-90s to around 0.33 in 2009-10. Between 2003-04 and 2009-10, the Gini in Australia increased by 0.022 points, a 7.2% increase in inequality.

Over this period, the share of household income going to the top 20% of households increased from 38.4%  to 40.2%, after reaching 41% in 2007-08. In 2003-04, a household at the 90th percentile of the income distribution had 3.87 times the income of a household at the tenth percentile. In 2009-10 this ratio was 4.21 times. This increase in inequality has happened during the mining boom period, and also during a period in which the income tax system was flattened out a fair bit. It’s likely that both factors have contributed to the rise in income inequality in the mid-to-late 2000s.

The OECD inequality data currently don’t go beyond the mid-2000s, so it’s difficult to say whether other countries have also become less equal over the same period.

Gini coefficient in Australia – mid 1990s to late 2000s

One of the most biggest problems associated with higher inequality is lower social mobility – the longer the ladder between top and bottom, the harder it is to make it to the top. Researchers measure this mobility as the relationship between an individual’s earnings and his or her parents’ earnings. If this is 1.0, then your income can be predicted with 100% accuracy based on what your parents earn. This implies no social mobility. If the figure is 0, then your earnings have no relationship to your parents’ earnings, implying high mobility. Australia has a moderate level of social mobility, according to research by Andrew Leigh, with an intergenerational elasticity of earnings in the range of 0.2 to 0.3. Dr Leigh explains:

In other words, a 10% increase in a father’s earnings translates into a 2-3% increase in his son’s earnings. In terms of international rankings, this suggests that Australia is more socially mobile than the US (IGE=0.4-0.6), less socially mobile than Scandinavia (IGE=about 0.2), and approximately as socially mobile as the UK. Given that’s where we fit in the inequality rankings, this feels about right to me.

I’ve written before about my belief that inequality matters. Even if we manage to eliminate absolute poverty within a country, inequality can still have pernicious effects on society and on individuals. One of the most harmful potential effects is that, over time, large inequalities of outcomes can undermine equality of opportunity, making it less likely that hard working, smart kids from poorer backgrounds will have a chance to achieve their potential. However, it’s important to keep the debate in perspective, at least as far as Australia is concerned. Income inequality here is rising, but it’s still relatively moderate. We should be vigilant to make sure that that our relatively egalitarian society stays that way.

NOTE: An earlier version of this post used a chart from the OECD to suggest that Australia’s level of intergenerational social mobility is relatively high. The OECD report used underlying data from a working paper by Andrew Leigh. The final version of his paper had a different finding about the level of mobility, but unfortunately the OECD report remains online with the original chart intact. I have updated my post to take account of this. Dr Leigh explains the whole situation here.

[fn1] The charts on the income shares of the top 1% are based on data from the World Top Incomes Database.

[fn2] Equivalised household disposable income is used for the OECD Gini data.

Albrechtsen:

The biggest problem when you hit the rich with higher taxes is behavioural. Here, the please-tax-me-more brigade might wish to take a look at the work of Arthur Laffer, a prominent economist during the Reagan administration. He and Ronald Reagan understood that lowering tax rates, rather than hiking them, led to increases in taxable income revenues…. When you tax people more, their incentive to work more and earn more income drops off. It’s “pure commonsense”, Laffer says.

Albrechtsen seems to believe that we are always to the right of the peak in the Laffer curve. On this view, tax revenues would presumably be maximised with tax rates of 1%. This implies that we don’t need to choose between higher tax rates with higher revenues on the one hand, or lower rates with lower revenues on the other. We can have low tax rates and maintain or increase our current revenues! All that is standing in our way, seemingly, is a bunch of short-sighted politicians, prodded along by class warriors who seek higher rates for no reason other than spite or envy.

The problem is that there is little empirical support for claims that cuts in tax rates from the rates that currently prevail in countries like the US and Australia will result in increased revenue. Even conservative Republican economists dispute the notion that tax cuts pay for themselves.

Bruce Bartlett, an official in both the Reagan and George H.W. Bush administrations, has said:

The original supply-siders suggested that some tax cuts, under very special circumstances, might actually raise federal revenues…

But today it is common to hear tax cutters claim, implausibly, that all tax cuts raise revenue. 

Here’s what N. Gregory Mankiw, Chairman of the Council of Economic Advisers in the George W. Bush administration, had to say about the Laffer curve and the Reagan tax cuts in the 1998 edition of his textbook:

An example of fad economics occurred in 1980, when a small group of economists advised presidential candidate Ronald Reagan that an across-the-board cut in income tax rates would raise tax revenue. They argued that if people could keep a higher fraction of their income, people would work harder to earn more income. Even though tax rates would be lower, income would raise by so much, they claimed, that tax revenue would rise.

Almost all professional economists, including most of those who supported Reagan’s proposal to cut taxes, viewed this outcome as too optimistic. Lower tax rates might encourage people to work harder, and this extra effort would offset the direct effects of lower tax rates to some extent. But there was no credible evidence that work effort would rise by enough to caues tax revenues to rise in the face of lower tax rates. George Bush, also a presidential candidate in 1980, agreed with most of the professional economists: He called this idea “voodoo economics.”

Nonetheless, the argument was appealing to Reagan, and it shaped the 1980 presidential campaign and the economic policies of the 1980s…. Congress passed the cut in tax rates… but the tax cut did not cause tax revenue to rise… tax revenue fell.

Mankiw’s position seems to be that, over the long run, tax cuts do have a positive effect on incentives. This means that some of the revenue lost via tax cuts is recouped via increased economic activitiy. This is a fairly uncontroversial proposition. However, his work on the size of this behavioural effect suggests it’s much smaller than Albrechtsen claims.

Here’s Mankiw in 2007:

In a paper on dynamic scoring, written while I was working at the White House, Matthew Weinzierl and I estimated that a broad-based income tax cut (applying to both capital and labor income) would recoup only about a quarter of the lost revenue through supply-side growth effects

This estimate accords with studies of the effect of the Reagan tax cuts of the early 1980s. Lawrence Lindsey, who was Senior Staff Economist for Tax Policy in the Reagan Administration and later served in the G.W. Bush administration, found that:

…at least one-sixth, and probably one-quarter, of the revenue loss ascribable to the rate reductions was recouped by changes in taxpayer behaviour.

In other words, for each dollar of tax revenue that is given up through tax cuts, the Government recoups around 15-25 cents through an increase in taxable income. Bear in mind that these estimates are those of conservative economists who worked in the White House under Republican Presidents. Their estimates of the effect of tax cuts on revenues should therefore be assumed to be on the high side.

Such tax cuts, on the Republicans’ estimates, still leave three-quarters to five-sixths of the lost revenue to be accounted for in some way. This can either be done by raising other taxes, cutting spending, or running persistent budget deficits.

If conservatives want to argue for a diminished role for Government, they should make the argument on its own terms, rather than hiding behind spurious suggestions that we can have our cake and eat it too. As Laffer himself has said, “”The Laffer Curve should not be the reason you raise or lower taxes.”

UPDATE: Here’s a useful summary of various views as to where the peak in the Laffer curve lies.

Following years of poor decisions by governments, we have a planning system that puts developers – not people – first.  

Many of us accept that Melbourne can’t keep sprawling outwards. But bringing more people into the city will only work if we invest in infrastructure, keep our open spaces and preserve Melbourne’s character and liveability.

Housing is becoming less affordable in inner-city Melbourne, but the guiding principle seems to be to turn every old warehouse or vacant site into expensive, high-rise apartments.

Adam Bandt wants more affordable housing, yet laments the trend to turn warehouses and vacant sites into new dwellings. This seems to be a widely-held view. People like affordable housing (at least in the abstract), but they don’t like change. I don’t understand the model of the housing market that people carry around in their heads if they think this way.

How can you reconcile a desire to see:

• consistent population growth;
• access to affordable housing;
• no expansion of the urban growth boundary; and
• strict restrictions on new development in existing areas?

The way I understand the housing market, the price is determined by the supply and demand for housing. If supply is artificially restricted, the price will rise. That may be a policy goal you wish to pursue, but it is not consistent with the policy goal of increasing access to affordable housing. There are trade-offs here that cannot just be waved away.

The negative effects of housing supply restrictions on productivity, creativity, and affordability are covered in a well-argued new Kindle single by Ryan Avent (of The Economist)  called The Gated City. Avent understands what motivates people to want to resist development:

Their actions aren’t necessarily nefarious. Most just want to protect neighborhoods, views, and buildings they love from changes they fear. But the cumulative effect of this battle against change is dramatic.

This is the key point. The small decisions to restrict housing supply, one apartment block or subdivision at a time, add up to less affordable cities.

The problem, as Avent says, is that:

No one in the city represents the residents or businesses that might want to live or operate in the developments yet to be built. But their interests should matter…

[T]he lion’s share of the cost of exclusion falls on the excluded. That’s why the practice of shutting others out is so attractive and so common. No policy I can suggest will be as effective as the understanding that the welfare of outsiders matters. 

Choose to support stringent restrictions on housing development, or support access to affordable housing. You can’t choose both.

You cannot take the politics out of tax. The question of how much is to be raised, the manner in which it will be raised, the balance between various revenue sources, and Governments’ allocation of revenue between expenditure items is intensely political. There is not some ‘right’ answer that an independent body of enlightened technocrats could stumble on, if only vested interests and politicians got out of the way.

When faced with a choice between equity, efficiency, and simplicity, governments can’t say “all of the above”. They have to choose between these ends. Their choice will inevitably be a compromise between competing interests and views, satisfying purists of no political persuasion and irritating tax accountants and lawyers who see the flaws of the legislation up close. This compromise between competing ends is a feature, not a bug.

Let’s take the issue of business tax. Before any Commission got to ‘evaluating reform blueprints’, they’d want to establish some facts about where we stand, both relative to our past and relative to other countries. What is the appropriate metric? Should we just compare statutory company income tax rates, or should we look at the effective rates once various loopholes, exemptions and deductions are taken into account? Instead of comparing rates, should we look at business tax a a proportion of GDP? Or should it be as a proportion of revenue? Should we include various other taxes if their legal incidence falls upon business? To what extent should we take into account the fact that the economic incidence of a tax is not necessarily the same as the legal incidence? If we are to take this into account, which of the array of studies should we lean upon to determine the distribution of this burden between capital and labour?

Once we’ve settled all of those questions, we still haven’t got far. We still need to decide which other countries we should compare ourselves to. Should we just look at the OECD? If so, should we weight OECD countries by population? Or perhaps we should only look at OECD countries that are similar to us in some way, either in terms of their social safety net, or their broad institutional structure, or the size of their economy? Maybe the OECD countries aren’t the right comparators at all; perhaps we should be looking at countries in our region, like Singapore or Hong Kong. How do we take account of the various non-tax regulations that affect business decisions in each country?

Each of these is an important question. I don’t think there is a ‘right’ answer to any of them. Perhaps you might suggest that a ‘reform commission’ would merely present ALL pertinent facts, essentially answering ‘yes’ to all the questions above. That would still leave the question of what is to be done, a question that ultimately should not and must not be delegated from our elected representatives. Maybe the Commission would merely model the economic and fiscal effects of various groups’ reform proposals. This could be useful, but I’m not sure it would ultimately be particularly helpful to governments (and they can, of course, already obtain such advice from Treasury and Finance). Governments would still need to choose between competing ends and between competing views.

I’m all for expanding the range of evidence that is available from trusted sources. I’m all for the idea of Government support for independent research, like the announcement that Wayne Swan made yesterday. I am just wary of the ideas that purport to take the politics out of politics.