Australia’s economic structure

The need to raise more public revenue, the Productivity Commission report on productivity, and the IPCC’s urgent message coinciding with the Senate’s strengthening of the safeguards mechanism, have brought pressure on the government to address structural change, particularly tax reform, with more vigour.

Do we need “big” government?

That’s the title of an ABC Big Ideas session recorded at Adelaide Writers’ Week, with Wayne Swan, Richard Denniss and Alan Kohler on the panel. It’s a broad-ranging discussion, and they wisely don’t argue the case for “big” or “small” government. But they do note that by comparison with other prosperous “developed” countries, and contrary to many people’s beliefs, Australia is a small-government-small-tax country. If we want good public services we cannot expect them to be delivered at bargain basement prices.

They make the common-sense point that the size of government, and therefore the amount of taxes we pay, should be determined by what we want governments to do for us, rather than by some arbitrary target size. That is, or should be, a question about values, as well as about the economics of the private-public division of economic activity, because there are some things the government does well, and there are other things the private sector does well.

Under successive Coalition governments, however, our public debate has been infected by the idea that the size of government should be constrained because “big” government is bad for the economy, and whatever the activity, the private sector is always more competent than the public sector. The Coalition, during its long period in office, decided that Commonwealth taxes should be no larger than 23.9 percent of GDP, and tried (generally unsuccessfully) to fit public spending within that arbitrary limit. The figure has no more logical support than Douglas Adams’ 42, in his Hitchhiker’s guide to the galaxy: in fact 42 would have been a better choice, because in most other high-income “developed” countries public spending is about 40 percent of GDP.

As Swan puts it, “the notion that a low-tax society will bring wealth and prosperity is a nonsense”. Kohler backs him up with his observation that Australia’s strongest periods of economic growth have coincided with our highest marginal tax rates. The idea that high taxes discourage entrepreneurship and investment is bunkum.

The unifying theme of the session is a rejection of neoliberalism – “a political virus which demonizes the role of government”. That demonization has been supported by the idea, based on a contrast of the “west” with the former Soviet Union, that “small government” and democracy are inextricably linked.  

The discussion is mainly about the political economy of public finance, covered in Denniss’s short book Big: the role of the state in the modern economy. A more detailed rejection of the “small government” ideology, drawing on mainstream economic theory, is in Governomics: can we afford small government?

Ken Henry on intergenerational equity and tax reform

Here are five observations on our taxation arrangements:

  1. Because we don’t have a proper resource rent tax we have missed opportunities to capture value from our resource sector and to reduce its destabilizing effect on the rest of the economy.
  2. Our tax arrangements relating to education debt, superannuation and housing have disadvantaged young people of working age while privileging well-off retirees.
  3. We are too dependent on corporate and individual income taxes, while we collect too little on consumption, land and wealth.
  4. Our tax arrangements have contributed to our low productivity performance and the poor competitiveness of our non-mining sector.
  5. Rather than engaging in comprehensive tax reforms, with benefits all around, over the last 20 years we have had piecemeal reforms, adding to inconsistencies and incoherence in our tax arrangements.

That’s a cryptic summary of press reports of a speech former Treasury Secretary Ken Henry presented to the Australia Tax Institute. Unfortunately the Institute has chosen not to mount the speech on its website, but the ABC’s Gareth Hutchens quotes at length from the speech: A quarry and an unfair tax system — why is this the economy young Australians are inheriting? The Financial Review also has a short summary: Henry blows whistle on Australia’s tax reform slumber. Michelle Grattan also has selected quotes, including Henry’s assertion that “Commonwealth tax revenue should be at least 2 percent of GDP higher”: Former treasury head Ken Henry says we need ‘big bang’ tax reform rather than incremental change.

While Henry’s messages are little changed from his 2010 Australian Future Tax System Review, they are delivered with a greater sense of frustration and urgency. Although the mining industry, the Murdoch media and the Coalition parties have been the strongest forces against tax reform, he does not assign blame to specific interest groups or parties. But he does comment on the general political situation, in which lobbies, on the “right” or “left”, can raise a fear campaign against specific aspects of tax reform. A systematic broad-ranging reform, covering not only taxes but also government transfer payments, would see disadvantages or inequities associated with specific measures easily outweighed by the benefits of system-wide reform – a win-win on all dimensions.

Ken Henry’s vision of tax reform generally aligns with the views of 59 economists, assembled in a Conversation article by Peter Martin: How top economists would raise $20 billion per year. The economists are asked to choose among 13 options on two criteria – allocative efficiency and equity. On efficiency land taxes and resource taxes top the list. On equity inheritance taxes, winding back superannuation concessions, and resource taxes top the list. It’s notable that resource taxes come out near the top on both lists.

Understanding productivity and why it’s important

In 1901 it took 31 minutes of work (at the average wage then prevailing) to buy a litre of milk. Now it takes only 2 minutes. Three months’ pay would buy a bicycle, today a bicycle would cost one day’s pay.

These are two examples used by the Productivity Commission in its work to inform the public of the importance of productivity. On its web page What is productivity? it lists four ways increasing productivity can benefit our lives. To quote directly:

It also points out that in comparison with other OECD countries our labour productivity is low – way behind the Nordic countries and the USA, and only just ahead of the UK. And our productivity performance has been falling in recent years, which is why wage growth has stalled.

This is part of the Commission’s introduction to its 5-year Productivity Inquiry Report, released on 17 March. In that report the main finding is that while in goods industries (manufacturing, farming, transport) there have been huge productivity gains, in human services productivity gains have been much harder to realize.

Its main recommendations are about investing in human capital, particularly through education – from schools through to lifelong learning. Its emphasis is not only on skills acquisition, but also on workforce adaptability. Also migration policies should be reformed to prioritize immigrants likely to find well-paid employment. In this regard “investor visas” should be abolished.

It recommends a raft of reforms to improve resource allocation, including measures such as road-user charges, abolition of remaining tariff duties, and selective deregulation where regulations are impeding productivity.

It notes how the diffusion of productivity-improving technologies has been slow, a problem it puts down partly to shortcomings among business managers. It also makes a strong public-good case for wider diffusion of research:

Recommendation 5.13: No-cost or low-cost access to ideas that have large public good value.

To support the diffusion of best practice and knowledge that has already been generated by innovative businesses, not-for-profits and government organisations, the Australian Government should … require open access to research principally funded by governments.

It calls for reforms in the non-market sector, where productivity is often hard to measure. It also calls for more rigorous consideration of the costs and benefits of government programs. (As one who taught these skills, I can confirm that there is a huge deficit in the capacity of senior public servants to think of costs, benefits and system-wide interactions of public policies.)

There are two recommendations that should resonate with those who have negotiated stronger safeguard mechanisms for emissions, and an extension of market prices as a means to allocate resources devoted to emissions reductions:

Recommendation 6.5: Make the Safeguard Mechanism Australia’s primary emissions abatement mechanism.

Recommendation 6.6: Increase the integrity of carbon offsets recognised by the Safeguard Mechanism.

While most economists would agree with the Commission’s general thrust – it is hard to argue against productivity – the report seems to downplay the prevalence of market failure in the private sector. And it has little to say about the heavy bureaucratic overhead, the economic distortions and perverse incentives imposed by our finance and insurance industries. For example its section “improving risk management and insurance” essentially calls for private health insurance to take the place of Medicare in many situations, ignoring the moral hazard, administrative inefficiency, and resource misallocation already evident in private health insurance. Some risk-sharing mechanisms are best handled by the public sector.

Steven King of Monash University, who is also a Commissioner with the PC, has a summary in The Conversation: I helped write the Productivity Commission’s 5-year productivity review: here’s what I think Australia should do.

The ABC’s Jake Evans has a short summary of the Commission’s report: Free uni lectures, expanded climate scheme and working visa overhaul among proposals in major productivity review. (Don’t get too excited about “free uni lectures”: it’s only in a specific context.)

If you have 20 minutes it’s worth listening to a podcast by the Grattan Institute, where Kat Chay interviews Danielle Wood on Australia’s productivity predicament. As Wood says. it’s easier than reading the Commission’s 9 volumes. One point noted by Wood is that in comparison with other technologies, such as railroads and electrification, the productivity gains from information and communications technologies have been less dramatic. Perhaps they are yet to be realized, or perhaps it is really very difficult to realize gains in a human service dominated economy.

In this regard Joe Walker in his Weekend Reading brings to our attention a 2021 article Could advanced AI drive explosive economic growth?. The report’s author, Tom Davidson, notes that there is still the possibility of “super-exponential” growth comparable in scope to that seen in the Industrial Revolution, but it would probably not be realized in this century.

The now-strengthened safeguard mechanism

It is fortunate for the Greens, and more importantly it is fortunate for Australia, that the Final Report of the Intergovernmental Panel on Climate Change came out while the government was negotiating with the Greens and independent Senators seeking strengthened provisions to the Safeguard Mechanism.

The IPCC report, and its implications for Australian policy, are summarized in a 10-minute interview on ABC Breakfast with Mark Howden: Time is running out to stay under 1.5 degrees.

To quote three of the crucial findings from the IPCC, stated with high or very high confidence:

A4. Policies and laws addressing mitigation have consistently expanded since AR5 [Fifth assessment report]. Global GHG emissions in 2030 implied by nationally determined contributions (NDCs) announced by October 2021 make it likely that warming will exceed 1.5 degrees C during the 21st century and make it harder to limit warming below 2 degrees C. There are gaps between projected emissions from implemented policies and those from NDCs and finance flows fall short of the levels needed to meet climate goals across all sectors and regions.

B2. For any given future warming level, many climate-related risks are higher than assessed in AR5, and projected long-term impacts are up to multiple times higher than currently observed. Risks and projected adverse impacts and related losses and damages from climate change escalate with every increment of global warming. Climatic and non-climatic risks will increasingly interact, creating compound and cascading risks that are more complex and difficult to manage.

C.5. Prioritising equity, climate justice, social justice, inclusion and just transition processes can enable adaptation and ambitious mitigation actions and climate resilient development. Adaptation outcomes are enhanced by increased support to regions and people with the highest vulnerability to climatic hazards. Integrating climate adaptation into social protection programs improves resilience. Many options are available for reducing emission-intensive consumption, including through behavioural and lifestyle changes, with co-benefits for societal well-being.

Howden describes the effort Australia has to make if we are to do our share in bringing the global rise down to 1.5 degrees. We have to reduce our emissions by two thirds by 2035, but they are still on the way up. That task, however, is not beyond us: there are many low-cost options for us to at least halve our emissions with substantial net economic benefits.

In this context the only criticism that can be levelled against amendments negotiated by the Greens and independents is that they are too modest, but at least they are in the right direction. Renew Economy’s Sophie Vorrath describes the amended measures in a short article “Huge hit” to coal and gas as hard cap and pollution trigger added to Safeguard reforms.

Has it really been a huge hit? Santos and Woodside shares are still trading well on the stock exchange.

A submarine economy

Some day a military historian will ask why, in the European conflicts between 1935 and 1945, Germany was able to build 1174 U-boats, while 88 years later Australia had no capacity to build submarines, but planned, with the help of a foreign country, to tool up within 17 years to build the first of 8 vessels in a joint manufacturing venture.

The same historian may wonder how Australia, the country that had been manufacturing aircraft engines during the Pacific War, had become so de-industrialized 80 years later that it had to seek technical assistance from the UK of all countries – a country in serious industrial and technological decline.

Understandably most discussion and criticism of the AUKUS deal has been about its military and security implications. The budgetary cost of AUKUS – “up to $368 billion” – has also commanded a fair amount of attention. (How did they arrive at an estimate with such precision?) To get some grasp of what $368 billion means, total annual Commonwealth government expenses are around $650 billion, of which $38 billion is for defence.

AUKUS, of course, is spread out into the never-never, and as Martyn Goddard points out in his Policy Postarticle – We’re getting submarines. So what will we lose? – a considerable amount of AUKUS spending will be at the expense of other defence projects. (Will we have to bring Wirraways and Sabres back into service?) Goddard’s article is mainly about security and defence aspects of AUKUS, but he concludes with an estimate that the annual budgetary cost of AUKUS in the immediate future will be $8 billion a year. Goddard also estimates that just to sustain a reasonable standard of Commonwealth services there will have to be another $72 billion in annual outlays.

Peter Martin uses the challenge of funding AUKUS to remind us that there is really no restraint on what governments can spend. So long as there are real resources available, governments can create money to spend on them. His Conversation article – How can Australia pay $368 billion for new submarines? Some of the money will be created from thin air – can be read as an endorsement of “modern monetary theory”, but that’s a poorly-named theory because while it is called “modern” it is really rooted in traditional monetary theory as Martin explains in old-fashioned terms about public finance. (It’s hard for most people to grasp the idea that governments can create money and run up debt, because they tend to think that governments should be managed in the same way as households, but that’s a misleading analogy.)

John Quiggin, writing in The Conversation, queries the cost of building the UK SSN-AUKUS submarines in Australia. The article’s headline – $18 million a job? The AUKUS subs plan will cost Australia way more than that – is somewhat sensationalized, for the $18 million comes from dividing the total project cost by the 20 000 jobs the project’s proponents claim it will create. But Quiggin’s general point is that we already have a significant skills shortage, and AUKUS will simply draw skilled labour away from other important activities, such as de-carbonizing the economy. If we need a fleet of nuclear-powered submarines (Quiggin is far from convinced that we do) we would do better to buy them from some country with advanced manufacturing technology, while we deploy our skilled workers to other national priorities.

The ABC’s Eric Tlozek reveals another way in which the project’s contribution to employment creation is over-hyped. That’s because US security laws would restrict many Australians, with solid Australian security credentials, from being employed in AUKUS-related projects, because they were born in certain countries: Anti-discrimination laws exemption may cost engineers work on AUKUS submarines. It’s a reminder that AUKUS is about far more than security and technological cooperation: it’s about our absorption of a paranoid US Weltanschauung.

Our beaches – untapped sources of public revenue

A resource for budget repair?

In times past, when city populations were smaller and less mobile, our urban beaches were rarely crowded, even on scorching summer days. In terms of economic theory our beaches were “pure public goods”. That’s because they were “non-rival” (my enjoyment of a beach did not conflict with your enjoyment of the same beach because there was plenty of space), and they were “non-excludable” (it was not possible to fence them off to keep out non-payers.) Up to now the only means for seaside councils to ration use of their beaches has been to charge exorbitant parking fees, to deter the riff-raff from outer suburbs.

That has all changed. Beaches in our coastal capitals have become congested. And with the same fences as are used alongside freeways to protect against animal incursion, it is possible to fence off beaches, particularly some of our physically small urban beaches such as Bondi and Cronulla that already have limited access points. Mobile phone technology would allow for unmanned gates to provide access to those willing to pay for their time on the beach. The apps could record time of entry and exit, and charge accordingly, with lower prices in winter.

These ideas are developed in an Economic Reform Commission discussion paper Capturing Coastal Consumer Surplus, which analyses the economics of user-charging for urban beaches. Revenue obtained from user charges could go towards services such as lifesaving, cleaning trash, and maintaining fences. Some benefit would accrue to beach users who would enjoy the relative solitude of uncrowded beaches. Also user-charging for beaches would capture revenue from foreign tourists who until now have been free riders, making no contribution to funding coastal services.

People unable to afford the fees or who want to spend a long time at the beach would still be free to drive to beaches distant from urban centres.

The authors go on to suggest that some of the most popular and accessible beaches, such as Bondi, St Kilda, Glenelg and Scarborough, while remaining in public ownership, could be leased to commercial firms, who, for a fee, would be given naming rights for the beaches, and would be able to sell space on the fences for advertising billboards.

The paper, available on the ERC website, includes the usual disclaimer that it does not present government policy, but government agencies do not stray far from prevailing economic orthodoxy in their publications. Such papers are often the means governments use to run an idea up the flagpole and see if anyone salutes it.

The Productivity Commission’s inquiry into philanthropy

Philanthropy is big business. In 2020 Australians gave $13 billion to charities, and taxpayers claimed $4 billion in tax-deductible donations. Fewer people are donating, but those who are donating are giving more, which explains why as a proportion of our economy tax-deductible donations are growing.

These are a couple of fragments from a paper prepared by the Productivity Commission as background information in its inquiry into philanthropy.

Treasury has asked the Commission to study “trends in philanthropic giving in Australia, the underlying drivers of these trends, and to identify opportunities and obstacles to increasing such giving”. [Emphasis mine]

Submissions are due by Friday May 5.

This is an important inquiry, particularly in light of the government’s desire to see an expansion of philanthropy. We could be moving along the path the USA has taken, where the very rich have substituted giving to charities for paying taxes. Philanthropic money flows to high-profile causes, particularly when they have strong lobbies, while tougher more intractable causes get overlooked. Donations from the rich tend to be pro-cyclical, although needs are counter-cyclical. Many donors have good intentions, but they don’t have the backing of tough and rigorous benefit-cost analysis that helps guide government transfer schemes. And there arises a belief that philanthropy can take the place of taxes, although in the USA, philanthropy’s overall contribution is very small compared with even that country’s miserly transfer payments.

The Commission’s web pages are hard to navigate. To get into the substance of their work, either click on the weakly-displayed link “Read the call for submissions”, or go there through this link where you will find a further link to the Commission’s informative paper.