Budget

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GUEST OBSERVER
We are not convinced that giving the largest banks in Australia $7.4 billion over the next ten years is good for the budget. – Opposition Leader Bill Shorten, leaders’ debate speech, May 29, 2016.
Opposition Leader Bill Shorten’s line of attack during the leaders’ debate focused squarely on the Coalition’s long-term plan to cut the company tax rate from 30 percent to 25 percent.
Twice during the debate Shorten said the proposed tax cuts equated to giving A$7.4 billion over ten years to Australia’s big four banks (National Australia Bank, the Commonwealth Bank, ANZ and Westpac).
Is that right?
Checking the source
When asked for a source to support that assertion, a Labor spokeswoman referred The Conversation to modelling conducted by think-tank The Australia Institute.
The Labor spokeswoman said:
"Bill was emphasising the clear point of contrast in this election campaign, which is that Malcolm Turnbull wants to spend $50 billion giving huge companies a tax cut while Labor wants to invest in schools, Medicare and growing good jobs."
The Australia Institute modelling
In a press release, The Australia Institute said that for their economic modelling:
"The value of company tax provisions was derived from 2015 full year annual reports for the big four banks. That figure summed to $11,123 million. That figure was projected forward to 2026-27 to give the no-change scenario."
To arrive at the figure of $7.4 billion, The Australia Institute modelling assumed bank profit would increase in line with nominal Gross Domestic Product. Under this assumption, the amount of tax payable would also increase in line with nominal GDP. This would give nominal increases of:
<ul>
<li>2.5 percent in 2015-16;</li>
<li>4.25 percent in 2016-17; and</li>
<li>5 percent in 2017-18 and subsequent years.</li>
</ul>
As the think tank noted in its press release, the company tax cuts would not affect the big banks until 2024-25. That’s when the 30 percent company tax rate will fall to 27 percent for all companies with further reductions of 1 percent per year, hitting 25% in 2026-27.
The Australia Institute calculated the following results:
<a href="/images/2016/05/31/image-20160530-7713-8cr5ue.png" target="_blank">Click to enlarge</a>
<img src="/images/2016/05/31/image-20160530-7713-8cr5ue.png" alt="">
A reasonable guesstimate – but not a fact
On these calculations, the “$7.4 billion over the next ten years” claim is not a fact. But it’s also not an unreasonable guesstimate – although it is, of course, really over the three years from 2024-25 through 2026-27. There is no advantage to the big banks over the first seven of the next ten years.
According to the Australian Taxation Office, the four big banks paid a total of $9.5 billion in company tax in the 2013-14 financial year.
The government has proposed increasing the turnover threshold below which the rate of company tax payable is 27.5 percent, from $10 million in 2016-17 to $1 billion in 2022-23.
The government’s proposed policy says that the company tax rate for all companies (including the four big banks) with turnover exceeding $1 billion will fall from 30 percent to 27 percent in 2024-25, and then by a further one percentage point in 2025-26 and another percentage point (to 25 percent) in 2026-27.
So, on that basis, The Australia Institute’s maths checks out.
A grain of salt
As with all economic modelling, this modelling and any claims based on it should be taken with a large grain of salt.
Any assumption about the banks’ profit growth over the next ten years is entirely arbitrary, and I have no idea whether it is at all justified. Only time will tell.
If the banks' profits grew by only 2 percent per annum over this period, then the benefit to them from the cut in the company tax rate proposed by the Coalition would be “only” $4.8 billion; if they grew by 10% per annum the benefit to them would be $12 billion (over the three years from 2024-25 to 2026-27).
Verdict
Shorten’s statement relies on modelling assumptions made by The Australia Institute think-tank about bank profit growth. It is not a statement of fact but rather a guesstimate. It is not an unreasonable guesstimate, but depends entirely on whether the think tank’s assumptions about bank profit growth come true or not.  
 <a href="https://theconversation.com/profiles/saul-eslake-665" rel="author">Saul Eslake</a> is vice-chancellor’s fellow, University of Tasmania and author for The Conversation. He can be contacted <a href="https://theconversation.com/profiles/saul-eslake-665" target="_blank">here</a>.
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Will Australia's largest banks get a $7.4 billion benefit from tax cuts over next decade? Saul Eslake 

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GUEST OBSERVER
Contrary to what Labor and the banks have predicted, revenue from the bank levy will likely be higher, even with deductions.
In this year’s budget papers, Treasury estimated that the bank levy will collect about A$1.5 billion in each of the next four years for the government. But this is actually a conservative estimate.
Labor has argued there will be a A$2 billion dollar hole in the bank tax revenue. This is based on the disclosure to the ASX of four of the five affected banks, on what they will likely pay government.
But the banks’ numbers assume there won’t be change to any decisions in response to the bank levy. Research shows this is highly unlikely, as bank customers have worn the cost for bank taxes like this, imposed after the global financial crisis in the UK.
In fact, if the economy keeps growing as many have predicted, and banks grow too, then the amount of revenue the government collects from the levy may even be bigger than Treasury estimates.
<h2>What we know about the bank levy</h2>
When it comes to what revenue the government can get from the bank levy, both the taxable sum, and the tax rate applied, determine what gets collected.
The budget papers specify the taxable sum as including “items such as corporate bonds, commercial paper, certificates of deposit, and Tier 2 capital instruments” but not “Tier 1 capital and deposits of individuals, businesses and other entities protected by the Financial Claims Scheme”. The bank levy will be an annualised rate of 0.06%, applicable for all licensed entity liabilities of at least A$100 billion from July 1, 2017. Small banks and foreign banks are exempt.
Although it is possible the bank levy would not be a deductible expense in calculating corporate income, precedent and statements by government indicate the levy will be deductible. Special taxes on the mining industry (including royalties and the petroleum resource rent tax), state payroll, land taxes, stamp duties and indirect taxes such as petroleum excise are all deductions in the calculation of taxable corporate income.
<h2>Errors in the assumptions about banks</h2>
Labor and banks also assume that the bank levy is a deduction in assessing corporate income. The preliminary data made public by four of the five affected banks indicates the gross revenue gain of the bank levy, less the reduction in corporate tax, will be less than the budget numbers.
That is, the net revenue reflects a 0.042% levy rather than the 0.06% rate. This also assumes shareholders will bear all of the net additional taxation.
But it also assumes the banks will not change any decisions. This is both a simplistic and an unlikely scenario.
In essence, the bank levy is a selective indirect tax on one of the inputs used by the large banks to provide financial services to their customers.
A more likely scenario is that the banks will seek to, and succeed in, passing forward most of the new indirect tax to their customers as a combination of higher interest rates and fees. From past experience, banks pass forward higher Reserve Bank of Australia (RBA) interest rates, just as they pass forward lower rates.
Given that the affected five banks account for over 80% of the market, together with the reluctance of most Australian business and household customers to switch banks, there is a high probability that most of the levy will be passed forward as higher bank interest rates and fees.
Should the banks pass forward most of the levy to their customers, the increase in bank revenue will match the increase of bank costs caused by the levy. That is, taxable corporate income will remain about the same. Then, the overall government revenue gain is given by the gross 0.06% bank levy.
<h2>The bank levy could even collect more</h2>
If the output and incomes of the five banks to pay the levy expand over the next four years, then we would expect additional revenue to be collected by government to increase over time. The budget papers, the RBA, international agencies and private sector economists all forecast economic growth. It’s unlikely that the big five banks would not also experience economic growth.
So the budget paper forecast that the bank levy revenue collection of about A$1.5 billion a year for each of the next four years, has to be on the conservative side.
The revenue estimates for the levy are forecasts or projections compiled in a world of uncertainty. So a lot is still up for debate, including not only the design of the levy but the future path of the economy in general and for the large banks in particular.
Details and assumptions underlying government estimates of the revenue from the bank levy are unclear. It would be an unusual precedent not to allow the levy to be a deduction in calculating corporate income tax, and so reducing the net revenue gain. But the implicit assumption of the bank released numbers of no decision changes by the banks is unrealistic.
If banks, as businesses in general, pass forward to customers much of an input tax, a large part of the first-round fall in corporate income, is offset by higher revenue. Government forward estimates of additional government tax revenue collected by the levy likely are on the conservative side.
John Freebairn is a Professor in Department of Economics, University of Melbourne and the author for The Conversation. He can be contacted <a href="https://theconversation.com/profiles/john-freebairn-90" target="_blank">here</a>.
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The government will likely get more from the bank levy than Labor or the big four think: John Freebairn

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GUEST OBSERVER
For the first time in some years we expect better estimates of the coming year’s deficit, due to higher commodity prices.
Infrastructure investment plans, including a new Sydney airport and a major national rail project, SME tax cuts and education spending are expected to be the budget highlights.
Rates Strategy: After years of disappointment, the budget should be welcomed by bond investors as it is set to confirm 2016/17 as the peak of government debt issuance
Revenue gets a boost from higher commodity prices.
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It has finally arrived. After a run of budgets when the Treasurer of the day has had to announce that the underlying budget deficit was larger than expected, this year we expect a modest improvement. 
Rising commodity prices have been the main source of support, as the bounce is expected to have delivered additional tax revenue. However, this positive effect has been partly offset by weaker-than-expected wages growth, relative to the projections in the May 2016 budget, making the overall improvement only modest. 
The projected budget deficit is expected to be AUD25bn (1.4% of GDP) in 2017/18 (estimated at AUD28.7bn in December 2016 and AUD26.1bn in May 2016). However, much depends on the government’s assumptions about commodity prices, which we expect to be cautious. As a result, we expect the projected return to budget surplus still will not be forecast to arrive until 2020/21, as previously forecast.
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The key policy initiatives in the budget (due to be handed down on 9 May 2017) are expected to be plans for infrastructure investment, including a second airport in Sydney and a new inland rail from Brisbane to Melbourne, a corporate tax cut for small and medium-sized businesses and a boost to education spending. The Treasurer has also announced that, for the first time, the budget will separately report debt that is earmarked for infrastructure from that used for recurrent spending. 
With Standard &amp; Poor’s putting Australia on ‘negative outlook’ for its triple-A sovereign rating in July 2016, a key question is whether Australia will get downgraded. With the budget set to look a bit better, an improving nominal economy and signs of some budget reform, we doubt a downgrade will arrive next week. 
Our new onshore AUD/NZ rates/FX strategist, Tom Nash, expects the budget to be positive for long-dated government bonds (ACGBs). Even allowing for the infrastructure spend, 2016/17 should mark peak ACGB issuance. 
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A rare improvement in the budget outlook 
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Largely thanks to continued strength in commodity prices, we expect the forecast budget deficit for 2017/18 will look slightly better than previously estimated. This would be a marked contrast to Australia’s recent budget history, which since 2009 has featured consistent downward revisions to the budget balance and the predicted return to surplus being pushed ever farther into the future. 
There was some rare good news in the December 2016 mid-year fiscal update, when the forecast 2016/17 deficit was revised a touch lower from AUD37.1bn to AUD36.5bn, in response to the lift in commodity prices seen during late 2016. However, the commodity-related boost was expected to be temporary and the projected deficits beyond 2016/17 were expected to be larger than previously forecast (Chart 1). 
Since the mid-year update, the strength in commodity prices has proven to be more sustained, especially for iron ore. Although iron ore prices have dipped in recent weeks from over USD90/t to around USD66/t, the mid-year fiscal update assumed a decline from USD68/t at the time to USD55/t by Q3 2017. 
Although the assumptions underlying the new budget estimates are expected to once again assume that commodity prices will revert to a lower level, they will probably be a little more optimistic than those used in December. This should deliver a stronger nominal growth outlook and, in turn, better revenue projections (Charts 2, 3 and 4). 
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As a rule of thumb, a 1 percent increase in nominal GDP lifts government revenue by around AUD3bn. The mid-year update assumed nominal growth of 5.75 percent in 2016-17 and 3.75% in 2017-18. While the former is not much different from our own expectation of around 6 percent, we see scope for the 2017-18 forecast to be revised up to 5.25 percent or above thanks to the continued strength in commodity prices and a likely upward revision to the real GDP growth outlook (Table 5). 
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Key expected policy initiatives provide signs of fiscal reform 
For some time now, the clarion call in our research has been for fiscal policymakers to focus on tax reform and infrastructure investment. As we have pointed out previously, Australia’s new growth engine is exporting services to Asia, including education and tourism, and if Australia is to remain competitive in services exports, better urban infrastructure is needed (see Australia’s broadening economic links to China, 8 November 2016). At the same time, we have noted that Australia’s tax system has become more dependent on taxes that distort economic behaviour, such as corporate and personal income taxes, and that reform of the tax system is needed. 
This budget is expected to show some progress on these fronts, although more reform is needed over time. Key initiatives are expected to include:
The government is set to announce that a new government-funded company will be set up to build a second airport in Sydney at Badgery’s Creek at an expected cost of A$5-6 billion. A new inland rail line from Melbourne to Brisbane is also set to be announced, at a cost of A$10-12 billion. These projects are expected to be off the government’s balance sheet, much as the National Broadband Network was funded in earlier years.
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The Treasurer, Scott Morrison, has announced that the budget will also, for the first time, split its accounting of new government debt into that used for capital spending, such as infrastructure, and current spending, such as public sector wages. This is a positive development that should allow a clearer assessment of government spending that is investing in future growth prospects and that which is being used for current consumption.
The government is expected to announce a significant boost to spending on primary and secondary education, of around A$19 billion over the next decade (figures as report by the Australian Financial Review on 3 May 2017), adopting an adjusted version of the opposition Labor Party’s previous proposal for a ‘needs-based’ funding model.
Tax cuts for small and medium-sized businesses have already been passed by both houses of parliament, but will be part of the budget. Businesses with less than A$50 million in turnover will see the company tax rate cut from 30% to 25% by 2026/27, with the reductions phased in at different rates for businesses of different sizes. The budget is expected to contain a proposal to broaden this to every company by 2026/27.
A range of previously proposed budget measures that have not passed through parliament will also be scrapped. These include cuts to Medicare proposed in the lead-up to the 2016 election as well as cuts to education and welfare spending. These are set to reduce budget savings by around A$8 billion. 
Structural budget deficit remains a challenge
Although the stronger commodity price story, along with some fiscal consolidation measures, are expected to make the budget bottom line look a little better, Australia still faces many years of sizable budget deficits. This is because the deficit is structural, not cyclical. That is, the deficit is not the result of temporarily weak conditions in the economy – and so an improvement in economic conditions cannot be relied upon to return the budget to balance (Chart 6).
Interestingly, the Australian Treasury estimates that the structural deficit has been consistently larger than the actual underlying cash balance over the past decade, despite below-trend economic growth. This is mainly driven by the large, budget-positive impact of high commodity prices outweighing the smaller, budget-negative impact of weak GDP growth.
The precise estimates of the structural balance are highly uncertain, as they rely on assumptions about the size of the output gap and the long-run level of the terms of trade. For instance, the IMF’s estimates suggest that Australia’s structural deficit has not been as large as the actual deficit. Nonetheless, regardless of its size, it seems clear that Australia does have a significant structural deficit and that an improvement in cyclical factors alone will not be enough to restore a balanced budget over the long term. Changes to fiscal settings will be needed.
A rating downgrade is unlikely at this stage
Despite ongoing budget deficits (both actual and structural), we do not expect Australia to lose its AAA credit rating. In an international context, Australia’s fiscal position is still strong; in particular, net debt remains low, although it has risen significantly since 2008 (Charts 7 and 8).
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With the budget deficit currently around 2 percent of GDP, and expected to narrow further in 2017/18, the government’s debt-to-GDP ratio is also close to stabilising.
The key factors that have been of concern to the major rating agencies have been: a lack of fiscal reform, due to political constraints; Australia’s persistent current account deficit; and high household debt levels, making balance sheets more vulnerable.
The key catalyst for Standard &amp; Poor’s putting Australia on ‘negative outlook’ for its triple-A rating in July 2016, was the close Federal election result and the rating agency’s expectation that this reduced the likelihood of ‘forceful’ fiscal action need to get the budget back to surplus. Since then, commodity prices have lifted, supporting tax revenues, and there are some signs that fiscal reform may be moving the right direction, albeit slowly.
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The current account deficit has also narrowed significantly, due to the recent lift in commodity prices, the ongoing rise in commodity exports as new capacity comes on line and continued growth in services exports (Chart 9).
Household debt has continued to rise and is at high levels, which is expected to be a continued point of focus for the rating agencies. At the same time, the prudential regulator, in a coordinated approach with the central bank, has been tightening its prudential settings to reduce the risk entering the financial system.
Rates Strategy: A bullish budget for bonds
After years of disappointment, the 2017/18 Budget is set to be positive for Australian Commonwealth Government Bonds (ACGBs) as it will likely confirm that bond issuance has peaked and fiscal consolidation is back on track. We have previously highlighted fiscal policy as one of the structural factors underpinning our bullish stance on the long-end of the curve (see ‘AUD Rates: Cheap enough’, 30 March 2017).
The Treasury is likely to confirm FY16/17 as the peak for ACGB issuance, despite uncertainty over the funding of infrastructure projects. Mid-year Treasury projections imply a sizeable 24% decline in gross issuance in FY17/18 (to AUD78bn), and a larger 43% decline in net issuance (to AUD44bn) compared to the current fiscal year. We present an alternative scenario in Table 10 that assumes that all of the announced infrastructure spending is funded by debt as well as incorporating our economics team’s estimate of improved revenues. Total bond supply is c.AUD10bn higher over the projection period under this scenario but 2016/17 remains the peak. 
While the duration of new ACGB supply is likely to stay high (the weighted average maturity has been 10.6yrs this fiscal year compared to 7.6yrs five years prior) we expect it to be well absorbed. The recent uptick in bid-cover ratios (Chart 11) as well as a continued gradual rise in offshore bond holdings implies a steady demand for duration.
With fiscal consolidation on track, HSBC’s base case is that this budget will not prompt any of the major credit rating agencies to downgrade Australia’s AAA credit rating. Importantly, an improved revenue outlook should give rating agencies more confidence that the public debt-to- GDP ratio stabilises in the near term and declines over the medium term as net bond issuance drops below 2% of GDP (Chart 12).
Australia’s Triple-A rating is positive for bonds primarily because politicians’ commitment to maintaining it encourages strict fiscal discipline. Reflecting this, Australia has the largest underlying fiscal consolidation embedded over the medium term among developed economies, based on the IMF’s standardized methodology (Chart 13). The pricing of credit risk premium is a secondary consideration for ACGBs given there is no real mechanical flow impact associated with a rating downgrade from AAA to AA and arguably yields already reflect a lower rating/ higher degree of sovereign credit risk (e.g. Australian sovereign CDS spreads already trade above the AAA average). 
<a href="https://www.about.hsbc.com.au/hsbc-in-australia/management-team">PAUL BLOXHAM</a> IS CHIEF ECONOMIST (AUSTRALIA AND NEW ZEALAND) FOR HSBC. 
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Better budget should protect rating: HSBC's Paul Bloxham

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GUEST OBSERVER
Government strategies to manage population ageing largely assume that older Australians are home owners.
There is often an implied association between home ownership and ageing well: that is, older Australians who own homes are seen as having made the right choices and as being less of a budget burden. 
The problem with this approach is that not everyone is or can be a home owner. A great many households are, for many reasons, locked out of home ownership.
My analysis of 20 years of federal government ageing strategies and age-focused analyses of the housing system shows that Australian governments of all persuasions have shared three common beliefs about the economic value of home ownership in later life. They have promoted home ownership as:
<ul>
<li>
somewhere to live;
</li>
<li>
an asset to rent or sell; and
</li>
<li>
a way to access and spend equity.
</li>
</ul>
<h2>Somewhere to live</h2>
Australian governments have valued and promoted home ownership because it provides somewhere to live in later life, with no regular ongoing costs such as rent.
As a 2015 Productivity Commission report argued:
"Because the majority of older Australian households own their homes outright, their housing costs are typically very low, yet they enjoy the benefits from continuing to live in their homes. […] This source of value (relative to overall household expenditure) becomes markedly more important with increasing age."
Owning a home is seen as largely cost-neutral, though the costs of maintaining housing are recognised in some documents. In contrast, the privately rented home is discussed as an ongoing financial burden. 
Home ownership is seen to provide economic security by freeing up income, so that people have greater disposable income for discretionary lifestyle spending in later life.
In other words, owning a home enables home owners to be consumers. While this can be seen as ensuring quality of life in older age, it also connects strongly with a broader government goal of growth in consumer spending.
<h2>An asset to rent or sell</h2>
Governments have also valued home ownership as an asset that people can rent out or sell so they can pay for costs associated with moving to “age-appropriate” housing. This includes paying bonds for retirement villages or nursing homes.
It has been suggested that older home owners are better equipped than, say, renters with the financial resources to make “appropriate” choices for housing and care in later life. 
For example, they might be able to afford to buy housing within an “active lifestyle community”. And any leftover funds can fund higher levels of consumption in retirement.
So, home ownership has been understood as an individualised way of managing the risks of ageing.
People who own higher-value housing are better off in this scenario, as they will reap greater profits if they sell their home, or secure a higher income if they rent it out. 
However, these benefits can be difficult to access. This is due to the very high costs of housing in some cities, and the risks associated with some retirement housing.
<h2>Accessing (and spending) housing equity</h2>
The third way governments have seen value in home ownership is through new financial products that enable home owners to access – and spend – home equity.
Emphasis is usually placed on the capacity to make a proportion of the home “liquid” while retaining overall ownership and the ongoing right to live in the house. For governments, this has two benefits:
<ul>
<li>
It enables older people to pay for more of the costs of older age, including for aged care. This is a way of shifting these costs away from the government in situations where people are seen as having the capacity to co-contribute.
</li>
<li>
It enables home owners “to pay for additional services over and above the approved care”, according to the Productivity Commission. This supports government goals for economic growth by expanding the aged care market.
</li>
</ul>
Funds released in this way enable lifestyle “choice” and better care in older age.
<h2>Home owners are winners</h2>
These three benefits suggest a system in which home owners are equipped with greater spending power – and hence choice – in older age. They are likely to have access to higher levels of care, and to be more able to make choices that enable them to age “well”.
Quite curiously, in some documents baby boomers are distinguished as desiring higher-quality services in later life. The capacity to access and spend home equity is seen as enabling this possibility.
The promotion of home ownership as a way of funding care in later life is part of a broader policy trend toward making people personally responsible for the opportunities they have in life. While this may make intuitive sense, it is unjust because it ignores factors that shape income and investment opportunities, including home ownership, over the life course.
Data from the 2016 Census show that households living on the median single-person income could not afford the median rent in Australia, and that home ownership is increasingly out of reach. 
Single older women are among the fastest-growing group of homeless people in Australia. And, for non-home owners, poverty in later life is on the rise.
Australia needs ageing strategies that do more than assume everyone is a home owner – or that home ownership is a simple choice.
<a href="https://theconversation.com/profiles/emma-power-250930" target="_blank">Emma Power</a> is Senior Research Fellow, Geography and Urban Studies, Western Sydney University and author for <a href="https://theconversation.com/au" target="_blank">The Conversation</a>.
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Three reasons the government promotes home ownership for older Australians

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GUEST OBSERVER
The government shouldn't cave to WA's calls for a change to the way GST is divvied out. The current system has served Australia well.
Treasurer Scott Morrison has acceded to pressure from his Western Australian colleagues in announcing another review of the way GST is divided up among the states and territories. But the current system shouldn’t be tossed aside just because the WA government was unable to control its spending.
Australia has long gone much further than other federations in seeking to “equalise” the way state and territory governments provide public services to their citizens. That’s one of the principal reasons why the disparity in living standards between Tasmania (Australia’s poorest state) and WA (our richest), is a lot less than that between, say, Mississippi and Massachusetts in the United States or even Mecklenburg-Vorpommern and Bavaria in Germany.
The Grants Commission was established in 1933, this is the body that decides how much GST revenue the states get in our current system. Since its establishment right up until the year 2000, WA has been the main beneficiary of “horizontal fiscal equalisation”(HFE).
That’s the principle that GST is assigned by. It assumes each state and territory should be making an equal effort to raise revenue from its own sources and by being equally efficient in its spending, to provide the same range and quality of public services as every other state or territory.
However, since the early 2000s, WA has become Australia’s richest state. This is the result not of any particular effort on the part of successive WA state governments, but rather of China’s almost insatiable appetite for the iron ore with which WA has been uncommonly endowed.
Over the five years to 2014-15, WA’s per capita gross product (what it produced) averaged almost 50 percent above that of Australia as a whole. This is a margin without precedent in Australia’s history.
This enabled WA to raise far more revenue per head of population than it, or any other part of Australia, had been able to in the past. This is also why in recent years WA’s share of the revenue from the GST has fallen to such a low level, relative to its share of Australia’s population.
Between 2005-06 and 2015-16, WA’s share of the revenue from the GST fell by about A$2 billion, from A$3.8 billion to A$1.8 billion. But its revenue from mineral royalties rose by almost A$3 billion over the same period, from A$1.2 billion to A$4.1 billion.
Despite the sharp decline in its share of GST revenues, the WA government’s total revenue per head of population in 2015-16 was just A$67 (or 0.7 percent) below the average for all states and territories. By contrast, by 2015-16 the WA government was spending over A$1,000 (or 10.5 percent) more per head of population on “operating expenses”, than the average of all states and territories.
WA’s present fiscal woes are the result not of a flawed system of distributing revenue from the GST among the states and territories, but rather of its inability to control its own spending.
Although an equal per capita distribution of GST revenues has become commonly used as a benchmark by government for assessing redistribution, it’s never been generally accepted that GST revenues should be distributed on an equal per capita basis.
Neither the federal government, nor the states and territories, allocate their spending programs on an equal per capita basis. Nor do they collect revenue in that way. There is no reason why an equal per capita distribution of GST revenues should be regarded as some kind of desirable norm.
As you can see in the chart below, if you did allocate GST in equal per capita, according to my calculations Queensland, the North Territory, South Australia and Tasmania would lose millions. But it would give Victoria, NSW and WA more of the GST revenue.
<a href="https://www.propertyobserver.com.au/images/2017/05/04/4.05%20graph.jpg" target="_blank" style="font-size: 12.16px;">Click to enlarge</a>
<img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2017/05/04/4.05%20graph.jpg" width="600" height="223">
It would be akin to reducing the top rate of personal income tax, paid by those earning more than $180,000 per annum and raising the bottom rate, paid by those earning less than $37,000 per annum, to the same figure.
Allocating GST per capita like this is not based on need or any policy and is quite abitrary.
The questions in the terms of reference, that the Treasurer has given to the Productivity Commission, were answered almost five years ago by a similar inquiry. This was conducted by former NSW Premier Nick Greiner and former Victorian Premier John Brumby, together with Adelaide businessman Bruce Carter.
Even though these state premiers had voiced the same concerns as the current government about the way GST is distributed, their inquiry recommended against any radical changes. They found many of concerns about the current system turned out to be overstated.
And, contrary to the Treasurer’s insinuation that “the current approach of horizontal fiscal equalisation creates disincentives for reform”, the previous inquiry concluded there was not enough evidence of efficiency losses in the economy.
I doubt that the Productivity Commission will find differently. There is room, to be sure, to make the Grants Commission’s procedures less complex and more transparent. But the principle which has underpinned the Grants Commission’s recommendations for more than 80 years has served Australia well, and shouldn’t be tossed aside merely to salve the self-inflicted wounds of Australia’s richest state.
 
Saul Eslake is vice-chancellor’s Fellow, University of Tasmania and author for The Conversation. He can be contacted <a href="https://theconversation.com/profiles/saul-eslake-665" target="_blank">here</a>.
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WA’s economic mismanagement is not a reason to review how the GST is carved up: Saul Eslake

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GUEST OBSERVER
The proposed housing affordability package in the May budget will target people relying on social housing as well as those trying to break into the market, Treasurer Scott Morrison has said.
Morrison said housing would be a very strong focus of the budget and he stressed the rental side.
“It won’t just deal with the challenges faced by first home-owners,” he said. “You have got to remember that over 30% of Australians actually live in homes that are rented, and when people are finding it hard to get into the housing market that puts a lot more pressure on the rental market.”
Noting that the number of people on low incomes in rental stress had gone up, Morrison said: “I am as much concerned about someone who is on a low income struggling with their rent as I am with someone who I know wants to get on the home-ownership market themselves. They are both important challenges for Australians.”
Morrison renewed his criticism of “one of the most disgraceful failures of public spending” – the National Affordable Housing Agreement. This was “a one-way cash ATM to the states which asks for nothing in return.
"We are handing over A$1.3 billion every year and the number of people on public housing waiting lists has gone up. The number of social housing dwellings which are owned by the state governments has gone down. We have basically shelled out billions and billions and billions for a program that isn’t achieving anything,” he told Sky. These were matters that would be addressed in the budget.
“We have to spend that money better. We don’t necessarily need to spend less on that. It is a very important issue,” he said.
He was frustrated as treasurer that while serious money was spent on a lot of problems, “the debate is so often that you need to spend more here. No, just spend what you are spending really well and more effectively and get the outcomes that we are accountable for.”
He said social housing often got overlooked in the debate, and he was “quite passionate” about it.
The Victorian government at the weekend announced relief from stamp duty for first home-buyers purchasing properties below $600,000. Investment properties would not be eligible. 
There will be a concession, applied on a sliding scale, for properties between $600,000 and $750,000. The exemption and concession applies to both new and established properties and the state government says it will help 25,000 Victorians with first homes.
Morrison also highlighted the problem of flat wages growth and the consequences that brought.
“Whether it is the NDIS [National Disability Insurance Scheme], whether it is schools, whether it is hospitals, whether it is Medicare – at a time when wages growth is admittedly and regrettably flat, Australians – particularly hard-working Australians on middle incomes – rely more and more and depend more and more on these services,” he said.
“And so the budget does need to signal, and the government has been signalling this, the need to ensure that people can feel confident about the support for those services.”
He made it clear that any improvement in commodity prices or wages growth would be used for budget repair rather than for new spending.
With an eye to the imperative that the budget must be convincing to the ratings agencies, Morrison said: “We have to deal with the political environment that we work in. You can’t just go out there and announce a whole range of things which you don’t have a reasonable prospect of being able to implement.”
He said Labor seemed “to be engaged in a very cynical process of sabotaging the budget to try and crash the AAA rating”.
“They won’t engage in getting spending under control, they want to see the nation’s welfare bill be higher. They want to tax people more to pay for a higher welfare bill.”
Michelle Grattan is professorial fellow, University of Canberra, and author for The Conversation. She can be contacted <a href="https://theconversation.com/profiles/michelle-grattan-20316" target="_blank">here</a>.
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Scott Morrison says budget will remember the renters

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<img src="https://counter.theconversation.edu.au/content/57114/count.gif" alt="The Conversation" width="1" height="1">
GUEST OBSERVER
Will this budget mark the inception of a new deal for Australian cities? And will it herald a new dawn for Australian local democracy?
Addressing the Australian Public Service in the Great Hall of Parliament on April 20, Prime Minister Malcolm Turnbull chose to emphasise that “smart cities” would be the engine room of innovation and growth in Australia’s new economy to be delivered through the concept of “City Deals”.
Turnbull said:
The “City Deal” approach used in the United Kingdom has been instrumental in the renaissance of Manchester and Glasgow, and we believe there are many elements that can be applied in Australia.
<h4>Turnbull’s address to the Australian Public Service.</h4>
But what is the value proposition underpinning the “City Deal”? And can it be applied here in Australia?
<h2>The value proposition</h2>
The value proposition has historical, democratic and economic foundations.
Historically, it builds on the role of iconic cities in the advance of civilisations. For example, the following quotation from Mel Sirotkin’s evocative work perfectly captures the central role of Manchester as the engine room of the Industrial Revolution:
During the Industrial Revolution Greater Manchester seized the initiative to become the world’s ﬁrst modern industrial metropolis. It is home to the nation’s ﬁrst public library, the birthplace of modern chemistry, and the professional football league. It is where Dalton developed atomic theory and Rutherford split the atom. Inevitably it is also where the rainproof mackintosh was invented.
Democratically, it forms the next logical stage in the UK’s constitutional reform program, which began under Tony Blair in 1997. Blair delivered Scotland’s parliament and assemblies for Northern Ireland and Wales, but the English voted “no” to English assemblies on the basis that this would be too much government to bear.
The argument for delivering devolution through existing rather than new institutions – in this case city regions – has proved far more palatable.
However, it is the economic credentials of the “City Deal” that prove most powerful. The Cameron government believes that larger local government units such as city regions led by elected mayors with new powers will help spread prosperity. This is based on evidence – such as from the independent RSA City Growth Commission – that the areas with the fastest growth and innovation around the world tend to have:
<ul>
<li>
large populations;
</li>
<li>
good connectivity;
</li>
<li>
high skill levels;
</li>
<li>
good infrastructure (including housing);
</li>
<li>
strong higher education institutions; and
</li>
<li>
empowered local leadership.
</li>
</ul>
The powers that the UK government is devolving to city regions are therefore focused mainly in areas such as transport, business support, infrastructure development and training.
A further economic argument for devolution to cities is that they provide a concentration of population and need. These in turn provide a potential focal point for innovation to foster economic development and improve service delivery and effectiveness.
In part, the argument is that necessity will be the mother of innovation. But there are also arguments that the greater scale of a city region provides fertile conditions for economic development. There is likely to be a greater pool of talent, experience and resources to draw upon.
Working across a larger area can promote more effective services. In many cases outcomes are likely to be better if several services are connected together. That applies, for example, to health and social care, to the various educational, health and social services that engage with families in trouble, and to the various bodies that can help prevent re-offending.
The argument for devolution to cities in England is mostly not about democracy, and more about economic competitiveness and service effectiveness.
<h2>What’s been achieved so far?</h2>
The way the deals have been negotiated reinforces the sense that this is about efficiency more than democracy. Deals have been cut within Whitehall in a top-down approach with various city regions according to their ambition and political clarity.
In most cases, an elected mayor has been added to the mix to provide a fig leaf of democratic legitimacy. But many of the deals have been criticised as a stitch-up between city and national elites with little input from citizens and little prospect of citizen control.
On the other hand, the ad-hoc approach of doing the deals city by city, region by region, means that progress has been rapid. Substantial devolution is occurring.
Although some worry about creating an unequal governance framework, others argue it’s about doing what works for different cities. The pragmatic patchwork program has been deliberately designed such that no two city regions must necessarily have the same deal and level of devolution.
The Greater Manchester City Deal is by far the most advanced but only started this month. So, in truth, it’s too early to say how the deals will work in practice.
<h2>How do City Deals translate to Australia?</h2>
It is easy to see why the “City Deal” concept resonates with the Turnbull agenda. The image of the Australian city region as a centripetal catalyst to economic growth is both in keeping with the gravity of international evidence and the demographic changes articulated in the 2015 Intergenerational Report. This forecast a range of significant productivity problems arising from shifts in demography, workforce and participation.
It also provides a living laboratory for Turnbull’s National Innovation and Science Agenda and, in particular, the work of Data 61 and the Digital Transformation Office.
Most tangibly, it provides an opportunity for Turnbull to connect the government’s agenda to the everyday lives of Australians. This is something the polls suggest he has been unable to achieve so far.
<h2>What would need to change make it happen?</h2>
There are maximalist and minimalist versions of the “City Deal”. The minimalist version would be simply to negotiate a series of Commonwealth-funded programs with states and territories to lubricate the innovation agenda in Australian cities. The maximalist version, required to emulate the UK “City Deal”, would require constitutional change.
Devolution UK-style involves the transfer of power to a lower level, in this case to a local city or city region administration. However, unlike its European and North American counterparts, Australia’s political elite still has a strange, unfathomable disdain for local government – which is not shared by its citizenry.
Most significantly, devolution is not in the gift of Commonwealth government, as local government is a creature of state and (to a lesser extent) territory government. Changing federal powers requires constitutional change.
As Turnbull himself admits:
"It requires a firm commitment to collaboration. Success is dependent on federal, state and local governments agreeing on a set of long‐term goals for cities and the investments, policies and regulatory settings to achieve them."
Is it likely that state governments would cede authority over the jewel in their crown – the state capital? It would be like turkeys voting for Christmas.
The smart money is on the minimalist version even though Australia’s future economic prospects require the courage and ambition of the maximalist version.
Mark Evans is professor of Governance and Director of the Institute for Governance and Policy Analysis and NATSEM, University of Canberra and can be contacted <a href="https://theconversation.com/profiles/mark-evans-97204" target="_blank">here</a>.
Gerry Stoker is fellow and Centenary Professor, Institute for Governance and Policy Analysis, University of Canberra and can be contacted <a href="https://theconversation.com/profiles/gerry-stoker-155351" target="_blank">here</a>.
Both are authors for The Conversation.
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Will Budget 2016 deliver a new deal for Australian cities?

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<img src="https://counter.theconversation.edu.au/content/75060/count.gif?distributor=republish-lightbox-advanced" alt="The Conversation" width="1" height="1">
GUEST OBSERVER
As the federal budget approaches, the government is grappling with ways to enhance housing affordability, including reforming the current 50 percent capital gains tax (CGT) deduction on property investment.
The Economics Society of Australia (ESA) Monash Forum polled economists on this proposition:
"Capital gains tax deductions for housing investment should be removed because they overstimulate the housing market, contributing to rising house prices."
This is a deliberately more extreme measure than the proposal reportedly being considered by the federal government, which is to cut the current discount to 25 percent. But we wanted to assess more generally the effect of capital gains taxes on the housing market.
The poll found 44.4 percent of economists agreed with a statement that the tax deduction should be removed entirely (22.2 percent agreeing and 22.2 percent strongly agreeing). But 40.7 percent disagreed with the statement (22.2 percent disagreeing and 18.5 percent strongly disagreeing); while 14.8 percent of respondents were uncertain.
<a href="https://www.propertyobserver.com.au/images/2017/03/24/Screen%20Shot%202017-03-24%20at%209.10.49%20AM.png" target="_blank">Click to enlarge</a>
<img src="https://www.urban.com.au/images/2017/03/24/Screen%20Shot%202017-03-24%20at%209.10.49%20AM.png" alt="">
While some economists support the current role of the CGT discount to avoid taxing the capital gains that arise as a result of inflation increasing house prices, as opposed to the valuation in the land or property due to development (Saul Eslake, Rodney Maddock, Nigel Stapledon and Doug McTaggart), others believe the tax should also apply to the gains as a result of inflation (Kevin Davis and Margaret Nowak).
Many argued the principle of the CGT discount is not a bad policy, however the level of the discount is generous and is open for abuse.
They also pointed out that changes in one type of tax will distort the economy, especially if it is only targeted to one type of asset, in this case property. Instead some economists suggested the approach should be a holistic reform to fix tax inefficiencies, and tax treatment should be equal between all forms of investment and saving.
Most of the economists agreed housing affordability policies should be focused mainly on housing supply and housing market constraints (as well as transport and infrastructure) to solve the crisis. Other policies such as shared-ownership schemes and government-backed bonds are also being considered.
<h2>Capital gains tax</h2>
The capital gains tax (CGT) is calculated at the effective marginal tax rate of the investor, on the capital gains made at the time of sale of the asset. Investors who hold an asset for longer than 12 months receive a 50 percent discount on the CGT liability, at the time of sale. For superannuation funds, the discount rate is 33.3 percent.
Owner-occupiers are fully exempt from capital gains tax on the sale of their primary residence.
Some of the options reportedly being considered by the federal government include decreasing the CGT concession to 25 percent, decreasing it to 40% discount (as recommended in the Henry Tax Review) only for property investments, or some other reduction in the CGT discount for property investments.
Another option is completely removing the concession if the property is sold in the initial investment years; and phasing the discount in after the investment has been held for some specified number of years.
<h2>The economists’ arguments for and against</h2>
Economists who supported removing capital gains tax deductions for housing investment said the discount provides incentives to over-invest in property rather than other assets that provide income. So by eliminating or reducing the CGT discount, the cost of capital will increase and buyers will reduce their demand for property, resulting in lower, more affordable house prices.
Those who agreed with the statement argue any change in the CGT discount to address property speculation should also be accompanied by reforming negative gearing. They argue that eliminating the CGT discount for property only would push residential investors towards cheaper properties or towards investing in other assets that maintain the CGT discount. 
Most studies find no evidence of capital gains advantages being a main incentive for investors holding residential property. However it appears to be a small factor in the intention of investing in residential property.
Click to enlarge
<img src="https://www.urban.com.au/images/2017/03/24/Screen%20Shot%202017-03-24%20at%209.13.22%20AM.png" alt="">
<a href="https://www.propertyobserver.com.au/images/2017/03/24/Screen%20Shot%202017-03-24%20at%209.14.00%20AM.png" target="_blank">Click to enlarge</a>
<img src="https://www.urban.com.au/images/2017/03/24/Screen%20Shot%202017-03-24%20at%209.14.00%20AM.png" alt="">
Those against the statement argue the timing may not be right as the housing cycle is currently at its peak, and the double digit house price appreciation rates are only seen in the inner-ring suburbs of metropolitan cities and only for houses and not apartments.
Economists would expect to see only a short-term drop in house prices if the CGT deductions are eliminated, as investors switch away from property and into other assets. So the remaining residential investors in the market would purchase cheaper properties, potentially still crowding out first-home buyers.
They would also hold the property for a longer period. In the medium to long-term, the reduction in residential investment would impact on the new and existing supply of housing, resulting in housing shortage and rising house prices.
Maria Yanotti is lecturer of Economics and Finance Tasmanian School of Business &amp; Economics, University of Tasmania and author for The Conversation.
She can be contacted <a href="https://theconversation.com/profiles/maria-yanotti-349557" target="_blank">here.</a>
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Capital gains tax concession is too generous

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<img src="https://counter.theconversation.edu.au/content/57114/count.gif" alt="The Conversation" width="1" height="1">
GUEST OBSERVER
When the Committee for Economic Development of Australia (CEDA) recently released its recommendations on how the government should balance the budget, it prefaced it with the statement “No economic problem in Australia is graver than the persistence of large budget deficits”. But precisely the opposite is true.
To understand why, it’s necessary to explain the economic work of David Alan Aschauer. Work that appears to have been ignored in the current discussion about budget deficits.
Aschauer investigated the effects of government spending on infrastructure in increasing of the rate of return on private investment and hence on the volume of investment in the private sector. His work has been accepted by an extremely wide range of economists. It is not new. His most-quoted article was published in 1989.
Moreover, Aschauer is a neoclassical economist; that is he belongs to what is currently the dominant school of economics. Since 1989 there have been many articles published by Aschauer and his followers.
Aschauer himself summed up his work in the following quote:
“On neoclassical grounds expansions of public investment spending should have a larger stimulative effect on private output than equal-sized increases in private consumption expenditure. Specifically, public investment is argued to induce an increase in the rate of return to private capital and, thereby, to stimulate private investment expenditure.
The empirical analysis indicates that movements in public investment bring forth movements in private-sector output which are four to seven times as large as the public sector outlays.”
Of course, there can be, and have been, arguments about the size of the effects that Aschauer estimated in his empirical work. The general tenor of these is that the figure is more likely to be closer to the lower end of Aschauer’s range than the top.
But when researchers at UNSW made estimates for Australia, they arrived at a figure they described as “very similar to Aschauer’s (1989) findings for the United States". They concluded that “public capital plays an important role in private production, a role which may often be overlooked”.
This provided evidence, they believed, of the positive relationship between public capital and productivity in the private sector in Australia in the 30 years before they wrote their article.
Both Aschauer and the Australian researchers Glenn Otto and Graham Voss used aggregate data – data for the whole public capital sector and for productivity in the private sector as a whole.
Their striking and important results do not remove the need for governments to pick public investment projects that are more likely to increase private sector productivity. The models they and Aschauer have used are too simple to give convincing answers to the question, which requires the use of much more sophisticated models. However, they do cast doubts on the likelihood of politically motivated public investment projects contributing anything to long-term growth in Australia. And they were not writing in an election year.
Current discussions about budget deficits largely ignore the work of Aschauer and are much poorer as a result.
If some attention had been paid to this work the gloom and doom of CEDA’s recent report would have been greatly reduced.
John Nevile is visiting emeritus professor, UNSW Australia and author for The Conversation. He can be contacted <a href="https://theconversation.com/profiles/john-nevile-139716" target="_blank">here</a>.
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Balancing the budget mantra overlooks benefits of infrastructure spending

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GUEST OBSERVER
The Federal Government has achieved a good balance between encouraging more housing supply as well as policies that make housing more affordable.
Federal Treasurer, Scott Morrison, has carefully balanced the need to boost housing supply with policy levers that make housing more affordable in this year’s budget.
To unlock housing supply the budget allocates $1 billion for critical infrastructure along with $70 billion for transport infrastructure while working with the states to reform planning systems to speed up development.
To encourage more affordable housing the budget has lifted the Capital Gains tax discount to 60 percent where private investment is made in affordable housing.
This will be a real incentive for the development industry to invest in this area particularly if the bond aggregator through the National Housing Finance and Investment Corporation is available to the private sector.
The proposal to have Managed Investment Trusts to develop affordable housing to hold for rent for more than ten years is another positive move.
The proposal to encourage older people to downsize from large houses through allowing up to $300,000 from the sale of a house to be invested in a superannuation fund is a good way to facilitate this process.
By not overacting in the areas of negative gearing and the potential to reduce capital gains tax reductions on property, the Government has clearly understood the sensitivities in the role of investors in maintaining a viable rental housing market.
To pull policy levers in an aggressive manor could lead to a devaluation in the main asset that many families rely on in their own home.
The establishment of the Western Sydney Airport Corporation with funding of $5.3 billion to drive this important game changer project for Sydney is important in maintaining the momentum for this giant project.
The allocation of $1.7 billion through the Asset Recycling Fund to the Sydney Metro project will help progress this important infrastructure that will underpin where new urban development can be located in metropolitan Sydney.”
We are impressed with the careful balance the federal budget has achieved between stimulating much needed housing supply while developing policies that help with housing affordability.
As indicated in the budget papers the state governments will now need to reform their planning systems to ensure more homes are built more quickly for Australian families.
The Federal Government in working with the states on planning reform must question why New South Wales standards for apartments are so much higher than those in other states.
The well-meaning but expensive standards in the NSW Apartment Design Guide are adding around $100,000 to the cost of an average apartment above that of other states.
The Urban Taskforce is keen to work with the federal and state governments to achieve reforms to planning systems that can speed up development.
Chris Johnson is chief executive officer of property development industry group Urban Taskforce and can be contacted <a href="https://www.urbantaskforce.com.au/index.php?option=com_content&amp;view=article&amp;id=97&amp;Itemid=126#.Vdaart55dFI">here</a>.
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