WE SHOULD BE ABLE TO MAKE VOLUNTARY PAYMENTS TO IRD

I’ve often thought that our tax legislation should allow people to make voluntary payments to the Inland Revenue Department.  In other words, it should allow IRD to accept payments in excess of the taxpayer’s statutory obligation to pay tax computed in accordance with the tax law.

At present if you overpay tax the system will generally refund it automatically.

I was reminded of this issue when reading this 5 April New Zealand Herald editorial which continued the paper’s campaign for increasing tax to pay for the Canterbury earthquake.

The government has resisted this idea on the grounds that it would hit an already weak economy.  A far better approach would be to cut wasteful and poorly targeted government spending.  A huge amount of government spending falls into these categories.

The Herald reports a poll that found 40% of respondents favour a temporary tax.

Whenever I see people saying they would be happy to pay more tax, I think they should be able to go ahead and do so voluntarily. In fact I would go one step further and allow voluntary payers to indicate the broad area to which they want their money applied, eg police, welfare.

It would be fascinating to see how much additional revenue IRD would receive.  I suspect not a lot.

First, my guess is that if people want to donate money for welfare purposes, most would give it to private charitable organisations in the belief that they are often more effective than the government in such roles.

Second, I suspect that many people who tell pollsters that they favour raising taxes want them raised on other people, not themselves. 

Anyway, if the law was changed to allow voluntary payments to IRD in excess of tax assessments we would soon find out how many people (like the Herald’s editorial writer) put their money where their mouth is.  The IRD could report aggregate payments in the same way that it reports other tax revenue.  What could be the objection to such a law change?

OPINION WITHOUT ANALYSIS IS PRETENTIOUS

It’s always frustrating to come across opinionated comment unsupported by evidence or reasoning.

A case in point is this February 25 New Zealand Herald editorial on last week’s Welfare Working Group report.

The editorial states:

… the group errs in spreading its net too widely. John Key’s queasiness related to women who had more children when they were already on the benefit being required to look for part-time work when their baby was just 14 weeks old. The intention is to stop mothers having additional children simply as a means of remaining a beneficiary. Every so often, an example of this gains publicity. It is probable, however, that the problem is overstated. Either way, the Prime Minister is right to rule out the proposal.

This is just fact-free ex cathedra opinion. It is “probable” that the problem is overstated?  There is no need to surmise. Did the leader writer not read the WWG report which states (p76), “In New Zealand, an estimated one is seven sole parents who enter the benefit system will have an additional child while on a benefit (and ultimately one in four of current sole parent beneficiaries)”?  That hardly looks like a small issue to me.

And what is the Herald’s alternative position? Does it condone the behaviour of the appalling, foul-mouthed Joan Nathan of MeGehan Close, a long-term beneficiary with six children, one of whom, befriended by John Key, is now in CYF’s hands because she is “better off” there and “it’s a life I can’t give her”? Does it think taxpayers should support such DPB recipients on an open-ended basis when most responsible, working families plan the number of children they have on the basis of how many they can afford to provide a good life for? What is its view on the responsibilities of the fathers in question? Does it support the other WWG recommendations on this issue, eg free contraception? Does it favour the minority recommendation that work obligations should commence after 12 months rather than 14 weeks? And why? We are not told.

The editorial goes on to say:

In the same way, the working group goes over the top in recommending that mothers should be forced to look for work once their first child turns 3. Many couples on two incomes may well be willing to return to work soon after a baby’s birth. But that does not mean other people’s priorities are wrong. In parenting terms, there is much to be said for mothers who stay at home with their pre-school children. Whatever the benefits of work, for the individual and the economy, insisting that sole mothers take paid work before their children attend school is a step too far.

It describes this recommendation as “radical” and “extreme”. By what standards?  Welfare researcher Lindsay Mitchell has pointed out that the United States and Canada have a range of ages according to the state or province, with the United States having a maximum of 1 year.

Social democratic Norway, France, Germany and Switzerland have been work testing at 3 for some years.

Why does the Herald think that New Zealand can afford a welfare system with rules that are more lenient than those of these much richer countries, with all the consequences for child poverty and social breakdown that they generate?

The WWG reports (p66) that three-quarters of recipients of paid parental leave returned to work within 12 months, and two-thirds of those returned to work after taking six months or less.

The expectation that, with exceptions, parents be required to look for part-time work of at least 20 hours per week once their child reaches three years of age, and thus relieve the burden on taxpayers and society, looks neither radical nor unreasonable to me.

The leading newspaper in New Zealand’s leading city could do better.

Closing The Trans-Tasman Gap

It was good to see the New Zealand Herald editorialising today on the need for new policy to close the income gap with Australia.

The editorial made some good points:

Two years on, after a fall resulting from the global financial crisis, the move westward is growing again, up 16 per cent from 2009 to last year according to the statistics department. And National, too, is reduced to waving at the departees, our economy marooned in low growth and higher unemployment than across the Ditch. The number of New Zealanders returning from Australia is relatively static.

And again:

In government its answers have been limited: reducing company tax, shifting some direct income tax to indirect GST, tinkering with labour and planning laws, trying to hold the annual increase in state spending rather than cutting it, but ruling out big ticket changes such as to Working for Families, interest-free student loans and raising the entitlement age for superannuation.

But then it rather lost the plot:

The economic growth and prospects of a small, primary-produce-exporting nation are not directly comparable to those of a big, diverse, less indebted neighbour.

Hang on a bit!  New Zealand was once a wealthier country (in terms of income per capita) than Australia.  Its geographical position hasn’t changed.  Australia has always had those minerals in the ground.  Australia and New Zealand are both relatively small countries but small countries can do just as well as large ones (think Luxembourg, Switzerland, Hong Kong and Singapore) provided their markets are open and competitive.

Now consider this statement:

New Zealand’s options for revival are relatively limited by lower productivity, high private foreign debt and an almost cultural aversion by the state and individuals to cutting spending in favour of saving and productive investment.

Options limited?  But it is institutions (like electoral systems) and policies (spending, tax, regulatory, social) that mainly determine whether countries prosper or not in today’s world.  New Zealand’s productivity growth performance was slightly better than Australia’s in the 1990s but fell sharply in the last decade as economic reform stalled and reversed.  Decisions on institutions and policies are for us to make.  The question to ask is: If New Zealand moved in the direction of the policy settings of countries like Hong Kong or Singapore, why wouldn’t the income gap with Australia close quite rapidly?  (Think Ireland when it had its act together.)

Another argument:

Little is being achieved in catching up with Australia and it is possible that no policy setting, short of changes that would spark far more serious social upheaval than a brain drain will deliver parity in the foreseeable future.

 [The government’s] … 2025 productivity task force, headed by former leader Don Brash, twice predicted that major change was needed, and was given an almost unseemly short shrift. Dr Brash’s prescription suffered from a political tin ear, unaware or unpersuaded by the risks of a voter backlash to wholesale cuts to welfare programmes and taxes and sales of state assets.

This is hyperbole.  There is no need for wrenching economic change (unless we dither and it is forced upon us again).  The Brash prescription was orthodox, not radical.  It was entirely consistent with OECD prescriptions. It wasn’t the Taskforce’s job to play at being politicians; it was to deliver economic advice on how to close the gap.  And the government has on its agenda a number of possible initiatives which, if adopted, could make a difference, as I noted in this article.

Finally, somewhat contradictorily, the editorial concludes:

For its own sake, New Zealand needs bold economic initiatives that will position the country for sustained growth.

Sadly, the Herald put forward no suggestions at all for “bold economic initiatives”.  If it disagrees with the 2025 Taskforce, what is its alternative programme?  How can citizens and voters buy into the idea of “bold economic initiatives” if our leading newspaper does nothing to point the way?  And it doesn’t help if its op-ed pages are littered with articles like those of Bryan Gould (13 last year, two already this year) and Peter ­­­Lyons whose economic prescriptions would see us falling further and faster behind Australia.

What grade for the editorial?  Could do much better.

THE TRUTH ABOUT PRIVATISATION: BLOG # 1

I am starting a blog series exposing myths in the privatisation debate.  It could become a lengthy exercise.

This one is on Air New Zealand.

Since Air New Zealand was effectively nationalised by the Labour government (I’ll leave aside here arguments about that controversial decision) it has often been regarded as a success story. Thus Finlay MacDonald in the Sunday Star-Times of 30 January described it as “a glamour product” and a letter in Friday’s Herald said “Air New Zealand is a classic example of a government/private partnership working well.” The government has also referred to Air New Zealand as a model of partial privatisation.

Under Ralph Norris and subsequently Rob Fyfe, I think it is fair to say that the airline has been innovative and performed well operationally. But the bottom line for any commercial business is just that: its bottom line. How has Air New Zealand performed for investors, the majority of whom are taxpayers?

The answer is, not well. 

One source of information is the Treasury’s Crown Ownership Monitoring Unit which published the 2010 Annual Portfolio Report in December last year. It tells us that for 2009 and 2010 Air New Zealand’s return on equity was 1.3% and 5.2% respectively.  While this period includes the recession, total shareholder returns in three of the last five years have been negative.  Air New Zealand’s total market capitalisation has more than halved since 2007 – from $2,776 million to $1,152 million in 2010.

Air New Zealand itself has reported in the past that it has not met its cost of capital. It appears that again in 2010 it failed to do so by at least 2%. Given the most favourable WACC of 8.4% and the operating return of 6.3%, the shortfall is 2.1% and equivalent to close to $100 million (NOPAT). 

A private firm that persistently under-achieves its cost of capital eventually gets restructured (like Fletcher Challenge in the late 1990s) or goes out of business.

What does a failure of a firm to meet its cost of capital mean?

First, it means that resources have been misallocated – scarce capital could have been employed where it yielded higher returns.

Second – which is saying the same thing – the poor profitability of a firm means that it contributes less to national value added or GDP (profits are a component of GDP). In other words, material living standards are lower than otherwise.

Third, a lack of profitability means that competition (with other airlines and transport modes in Air New Zealand’s case) may be distorted, reducing potential national income further.

Fourth, in the case of a taxpayer-owned business, taxes (or borrowing) will have to be higher, other things being equal, to make up the profit shortfall.

Some people may be happy to see governments owning unprofitable airlines, rail businesses or other enterprises out of nostalgia and for other reasons.

But they should recognise that investing in socially unprofitable activities (like Think Big) has been an important part of New Zealand’s economic problems and will hold back economic growth and increases in living standards.

MORE ON ECONOMIC JOURNALISM

Brian Fallow isn’t the only journalist given to economic howlers (see the last point in my blog of 28 January).

Here is Tracy Watkins in the Dominion Post the next day making the same mistake:

There are no guarantees, meanwhile, that their sale won’t ultimately exacerbate New Zealand’s foreign debt position, given the possibility of shares ultimately being traded into foreign hands.

And here is Simon Collins in the Herald of 29 January:

Partial foreign ownership of our economy will increase” because “New Zealanders will be free to sell at least some of their shares to foreigners.

To spell out the point I made in my 28 January blog, here are the answers to Questions 4 and 5 of this report by Phil Barry:

4 Hasn’t privatisation led to more foreign control over New Zealand?

No. First, privatisation does not lead to a change in net claims by foreigners over New Zealanders. Rather, privatisation changes the mix of foreign liabilities, with the proceeds of any investment by foreigners being used effectively to repay foreign debt. Secondly, regardless of whom the shares are sold to, the assets stay in New Zealand, as do the jobs and the government’s sovereign powers to tax and regulate. Further, there are very good reasons for allowing foreigners to participate in the sale process. The number of (potential) bidders is increased, thus increasing the likely sale proceeds for the taxpayer. In addition, foreign ownership facilitates the transfer of international industry-specific expertise to the domestic firm. This transfer will in turn also increase the expected revenue raised from the sale (in a widely marketed sale, the purchase price will reflect fully the discounted expected cash flows)50 and the expected efficiency of the firm. Potential ownership by foreign companies also broadens the pool from which managers can be selected. Listing the firm in foreign share markets may also offer some advantages through increased monitoring, potentially extended information disclosure requirements and a ‘deeper’ market for the shares.  Finally, it is not the case that all the Crown assets have been sold to foreigners. Analysis of the residency of the buyers of assets (refer Annex 4) shows that around two-thirds of the assets (by number and value) were sold to combinations of foreign and domestic owners and around one-third to predominantly (that is, over 75 percent foreign-owned) or solely foreign-owned concerns. 50 As long as property rights are expected to be secure: refer to Maskin (1992).

5 Hasn’t New Zealand lost out from the huge sums of money sent overseas in dividends by the former SOEs? Hasn’t privatisation been a significant factor behind New Zealand’s large current account deficit?

Some observers point to the dividends being paid to foreign owners by former SOEs  as ‘proof’ that privatisation has increased New Zealand’s current account deficit. But privatisation is not to blame for the deficit.

With a floating exchange rate, when a foreigner buys NZ$1 of New Zealand assets, they must exchange it for a NZ$1 claim on foreign assets. The net claims on New Zealand from the rest of the world are unchanged. It is only if subsequent returns on the New Zealand or foreign assets are different from those expected at the time of the sale that there will be a (positive or negative) effect on the current account. Returns on individual investments by foreigners in New Zealand and by New Zealanders offshore will, in some cases, have exceeded average market returns and in other cases they will have been below average market returns.

But, as noted in response to question 2 above, there is no reason to expect that the returns on investments in privatised assets in New Zealand will have systematically been above average market returns.  As noted in response to question 4 above, privatisation did not increase (or decrease)  the country’s net foreign liabilities. If the assets had not been privatised, it is true that there would be less dividends going offshore, but there would also be more interest payments going offshore as New Zealand’s overseas debt would be commensurably higher. The overall effect on the current account would be very similar.

I can see that demythologising privatisation myths among journalists (and many members of the public) may be a lengthy process.  I might start a special blog on it.

ECONOMIC JOURNALISM GETS A FAIL MARK

Some of what passes for economic journalism in New Zealand is not impressive.

A case in point is this article in yesterday’s New Zealand Herald by Brian Fallow. Headlined ‘Ideology and tribalism behind questionable policy’, it poured cold water on the government’s partial privatisation announcement.

‘Ideology’?  Around the world governments of all political persuasions have been getting out of running commercial businesses for over 25 years.  Labor governments at federal and state levels in Australia, for example, have been to the fore. The only ‘ideological’ underpinning of policies in the world today seems to be the socialist attachment to ‘public ownership of the means of production, distribution and exchange’ in a few countries like Cuba – although even Cuba is changing – and North Korea, and in the policies of the last New Zealand government.

“There isn’t all that much family silver left in the cabinet.” Well, just a mere $18 billion, according to the December Investment statement, all or most of which belongs in the private sector. ‘Family silver’: is this economic analysis or politicised rhetoric?

“It does nothing to deal with the … perilously high reliance on foreign capital and credit.” This is a reference to New Zealand’s large current account deficits and increases in external liabilities under the last Labour government. These were due in part to a loss of international competitiveness as the government turned its back on efficiency-improving reforms such as privatisation.

Then the inevitable foreign ownership bogey: “once sold, it would be difficult … to prevent the new owners from selling them to foreign investors”.  No explanation is given as to why foreign investment would be a bad thing. A large part of the shareholding of companies like Telecom is inevitably and desirably in foreign hands: it would be unwise for New Zealand institutions to hold large parcels in their portfolios.

Then a real howler: “To the extent that these shares end up in foreign hands, they would increase the country’s net foreign liabilities …”  But a foreigner buying shares has to purchase them in New Zealand dollars, and the seller than acquires the same amount of foreign currency assets. The country’s net liability position is unchanged.

Fortunately, the Herald did better in an editorial the same day which supported the privatisation initiative.

Myths about privatisation abound, even though they have been debunked many times. For a rebuttal of some of them, see this report by Phil Barry.

A Perspective on Ireland’s Economy

Philip Lane is Professor of International Macroeconomics at Trinity College Dublin.  He is also a managing editor of the journal Economic Policy, the founder of The Irish Economy blog, and a research fellow of the Centre for Economic Policy Research.  His research interests include financial globalisation, the macroeconomics of exchange rates and capital flows, macroeconomic policy design, European Monetary Union, and the Irish economy.

Last week he visited New Zealand as a guest of the Treasury, the Reserve Bank, and Victoria University.  During his visit he presented this guest lecture on the troubled Irish economy, drawing on his recent report to the Irish Parliament’s finance committee on ‘Macroeconomic Policy and Effective Fiscal and Economic Governance’.

Some highlights from his talk (also reported here by Brian Fallow in the New Zealand Herald) were:

  • Ireland’s is a real depression: 15% fall in GDP 2007-2010
  • The Celtic Tiger 1994-2001 was no mirage
  • The domestic bubble (2003-2007) was partly the result of Ireland’s membership of the Eurozone, which produced interest rates that were too low for a booming economy.  When it burst, the problems were compounded by the global crisis
  • The banking crisis followed.  The excessive government guarantees to subordinated and senior bondholders were a major mistake (although bank shareholders were punished)
  • This precipitated the fiscal crisis, with successive austerity budgets and ultimately the EU/IMF bailout
  • Ireland has ‘bitten the bullet’ with cuts to public spending, wages, the minimum wage and welfare (although the cuts return most payments to around 2006 levels).  This amounts to an ‘internal devaluation’ given the fixed currency, and has boosted prospects for the real economy
  • The consensus in Ireland is to return to the core principles of the ‘Celtic Tiger’ era.

Asked whether Ireland would raise the 12.5% tax rate on inward investment, Professor Lane’s answer was, “never, ever”.

His account of Ireland’s rise and fall contrasts starkly with those of critics who saw Ireland’s predicament as a failure of ‘the neoliberal model’.

An example is this article by New Zealand journalist Alison McCulloch (‘Folly of Tiger is a warning for New Zealand’, New Zealand Herald, 24 April 2010).

I wrote this article in reply but the Herald declined to publish it.