WATCH OUT FOR ECONOMIC LITERACY – OR THE LACK OF IT

Later this week the Labour Party is expected to unveil further policy, including a plan to introduce a capital gains tax.

I will not go into the general pros and cons of a CGT in this post.  Many (myself included) think a CGT in some form has attractions in theory but that these are outweighed by thorny administrative considerations.

Rather, I focus here on the claim that a CGT on rental properties would dampen house price increases and make housing more affordable.  According to Trans-Tasman, “Labour says New Zealand is one of the few nations which doesn’t have a CGT, and it will help prevent future speculative bubbles in the housing and rural property markets.”

First, what does theory tell us?  Theory would suggest there is little relationship over time between house and other asset price increases and the presence or absence of a CGT.  The introduction of a tax on investment properties could be expected to have largely a one-off effect (as with the introduction of GST): prices would fall to the point where previous after-tax returns were restored.  But from that point on, normal supply and demand factors would largely determine the path of price changes.

Indeed the introduction of a CGT that is applied when capital gains are realised rather than progressively as they accrue could have the opposite effect to that assumed by Labour, at least for a time.  Some owners of investment properties might keep them off the market longer to avoid paying the tax.  Prices could go up rather than down.

As far as rents are concerned, there is no reason to expect a fall.  To the extent that property investors succeeded in passing on some of the costs of a CGT, rents would be higher than otherwise. 

Does the empirical evidence support the theory?  It appears so. New Zealand experienced a large increase in house prices in the last decade, but so did Australia which has a CGT.  In its recent report on New Zealand, the OECD commented that “This surge in real house prices appears to have been triggered by the combination of a sharp inflow of migrants and easy credit conditions.”  It added, “With similar developments occurring in Australia … a common Australia-wide macroeconomic trend appears to explain over 90% of movements in NZ house prices, giving rise to what amounts to a single housing market across both countries.”  No mention of a CGT playing a role.  Other countries with a CGT experienced similar house price increases.  The OECD commented that “the introductions of capital gains taxes in Australia (1985) and in Canada (1972) did not have any noticeable immediate impact on aggregate house prices.”

On New Zealand, the OECD also noted that “Between 1990 and 2001, national average house prices had appreciated at an annual rate of only 2% in real terms, and even fell in a number of districts.”  Clearly the absence of a CGT had no appreciable effect in that period.

For completeness, it should be noted that the OECD recommended a CGT or some other approach to reduce the tax bias in favour of housing (not to curb price increases).  My preferred approach to this issue is to steadily reduce all high income tax rates (say to 20% or below).  This would not eliminate the distortion but it would make it much smaller.

In line with the OECD’s findings, the New Zealand Productivity Commission noted in its recent Issues Paper on housing affordability that:

A combination of both supply and demand factors have been identified in explaining the surge in real house prices.  These include a sharp inflow of migrants during the cycle, favourable credit conditions, a rise in average incomes, declining nominal interest rates, very low unemployment, strong gains in the terms of trade during the period (with dairy prices driving up rural land values), response lags of residential construction, increases in the costs of building homes and shortages in materials and skills.  These factors likely inflated expectations of future house price increases, though it is difficult to determine whether a housing bubble had formed.

No mention of (the absence of) a CGT in the Productivity Commission’s analysis either.

A further point is that it’s hard to see how a tax that does not apply to owner-occupied houses, which account for the lion’s share of the housing stock, could be expected to have a material impact on house prices generally.

A final irony is that Labour is apparently proposing an increase in the top personal tax rate.  A similar move by the last Labour government was regarded by many analysts as contributing to house price increases, whereas the present government’s moves to lower the top personal rate and the rate for most PIEs have reduced the relative attractiveness of housing investment.

It will be interesting to see whether journalists merely recycle claims that a CGT will “dampen house price increases” or seriously challenge them.

Successful reform: past lessons, future challenges

Gary Banks, the chairman of Australia’s highly regarded Productivity Commission, is a valued colleague and good friend of New Zealand.

Last week he gave an important speech with the above title on economic reform in Australia.

It comes at a time when the Gillard government is struggling to establish its reform credentials.  Both major parties in Australia compete to embrace the Hawke-Keating-Howard reform legacy, unlike their counterparts here which often distance themselves from a similarly successful reform programme (even though they have kept in place its main elements).

Gary began by reflecting on the current climate of opinion about reform:

Paul Kelly, Australia’s pre-eminent policy journalist and chronicler of our reform history over the past three decades, asserted earlier this year that “the historic post-1983 reform era is terminated”. Ross Garnaut, one of the most policy-influential academics of that era, recently made the following assessment: “Economic policy since the GST [2001] has been characterised by change, rather than productivity enhancing reform”. He went further: “Attempts at major reforms have failed comprehensively and poisoned the well for further reform for a considerable while”.

 He observed:

If ‘productivity enhancing’ reform is indeed becoming a no-goer, Australia is in for a tough time. For a start, this would make it harder for us to meet the fiscal challenges of the Global Financial Crisis in the short term and, in the long term, the ageing of the population. We would also struggle to meet the demands and costs of more sustainable resource use and desirable environmental rectification. Australians may again start to see international competition and globalisation as threats rather than opportunities. And our capacity to raise the living standards of Indigenous and other disadvantaged members of the community would be weakened when it needs to be strengthened.

Explaining the importance of productivity growth, he said:

Productivity enhancing reform is so crucial to our economic (and social) futures because productivity growth itself – the ability to get more out of a country’s resources – is the mainstay of economic progress …  If, as the Nobel Laureate Paul Krugman has famously put it, ‘in the long run productivity is nearly everything’ Australia’s prospects currently may not appear very promising. Following a stellar performance in the 1990s, driven in large part by the structural reforms initiated in the previous decade, our productivity growth in the early 2000s fell back to its long term average.

Putting numbers on the productivity challenge, Gary commented:

… if (labour) productivity growth could just get back to the long-run average rate of 1.75 per cent that preceded the 2004-2008 cycle, rather than the 1.6 per cent average growth assumed in Treasury’s latest Inter-generational Report, then, abstracting from changes in the rate of employment and investment, per capita incomes would be 6 per cent higher by 2050. And if we could reclaim the 2 per cent average annual growth recorded in the 1990s in a sustainable way – admittedly a big ask – Australia’s GDP would be some $400 billion larger than otherwise, with per capita incomes 17 per cent higher (worth nearly $19,000 per person in today’s dollars).

New Zealand’s productivity growth was actually a little better than Australia’s from 1992-2000 following its earlier reforms, but declined more dramatically than Australia’s in the past decade with the changed policy approach of the last Labour government.

Gary noted that according to the dictionary, ‘reform’ means “change for the better”, but quoted Nicolo Machievelli’s famous remark about its challenges:

There is nothing more difficult to carry out, more doubtful of success, nor more dangerous to handle, than to initiate a new order of things. For the reformer has enemies in all who profit from the old order, and only lukewarm defenders in those who would benefit from the new.

He talked about where the backing for Australia’s reforms came from:

Support was strongest among the professional policy cadre – within government, academia and the ‘commentariat’, including opinion media. But there was also strong support from peak business, and to some extent from community organisations, depending on the reforms. Broader ‘public opinion’, if not actively supportive, was at least not actively hostile.

In New Zealand’s case, support from academics and the media, with some exceptions, was notable by its absence.

And a little further on in the speech, Gary Banks added:

Leaders with the right vision for a better Australia and the skills to realise it, were fundamental to all the individual ‘success factors’ just described – they could be said to be have been the ultimate success factor.

He ended by listing some of the priority areas for reform in Australia today:

One key dimension is the budgetary constraints that governments face in the aftermath of the Global Crisis.  The combination of fiscal constraints from the Global Financial Crisis and structural pressures from the mining boom suggests that the productivity enhancing reforms that deserve some priority right now are those that can reduce business costs and enhance the economy’s supply-side responsiveness, while being ‘fiscally parsimonious’.

In addition:

Regulatory proposals that would have pervasive effects across the economy need particular scrutiny, especially those impacting on the markets for labour and capital, and key infrastructural inputs to production such as transport (not forgetting coastal shipping), energy, telecommunications and water … Among these, industrial relations regulation is arguably the most crucial to get right. Whether productivity growth comes from working harder or working ‘smarter’, people in workplaces are central to it. The incentives they face and how well their skills are deployed and redeployed in the multitude of enterprises that make up our economy underpins its aggregate performance.

Practically all of this agenda and more applies to New Zealand.  (Water reform, for example, has not even got off the ground whereas it has been underway in Australia for two decades.)

The full speech is here.

A speech with similar themes is this one, Reigniting Reform in Australia and New Zealand, given by Hugh Morgan, president of the Business Council of New Zealand, to a New Zealand Business Roundtable retreat in 2004.

Unresearched dribble?!

I received so many comments (for my fledgling blog) on my post Protectionism in our backyard that I thought I would respond with another blog post. Flattered as I was to discover how many Zespri growers are apparently among my readership, I thought this comment at least required response:

What absolute uninformed and unresearched dribble.
Put some skin in the game and I doubt you would barking on about philosophical rhetoric….

Unresearched dribble?!  Can any serious participant in this debate be unaware of the enormous amount of research done by the Business Roundtable on agricultural marketing regulation, in general in this ACIL report and then later in a specific study on kiwifruit in this report?  This research was highly influential in the decisions taken by past governments to deregulate producer boards.  Export monopolies for dairy, pipfruit and kiwifruit were all to be removed.  Kiwifruit was stated to be only a matter of time.

Other respected organisations such as the Productivity Commission in Australia have advised against single desk regulations.  With one or two exceptions they have been dismantled worldwide.  Why should kiwifruit in New Zealand be an exception to well-established research findings and governmental decisions?

More recent arguments for kiwifruit deregulation were made in the 2009 report by NERA Economic Consulting here.  The 2025 Taskforce called for the monopoly to be removed.

Turners and Growers have presented facts about pipfruit deregulation here. There are no serious calls for the pipfruit industry to be re-regulated, yet nothing stops the government from doing that if it were desirable.  The profitability of land use is the basic reason for the growth or contraction of land-based industries, not marketing arrangements.  Wool has contracted relative to the deregulated dairy industry for this reason.

Bottom line: it is an extraordinary restriction on the freedom of a producer to ban them from selling something they have produced to a willing buyer in New Zealand or anywhere in the world.  We do not impose that restriction on hundreds of thousands of other New Zealand producers, including horticultural producers.  It would be ludicrous to argue that they should have to get the consent of a competitor for the right to export.  If Zespri is as good as it says it is it may lose no business – but potential competition will keep it on its toes and protect growers. 

National as a party and in its 2009 Government Statement on Regulation states that it is for free enterprise and against monopolies.  Where is the serious piece of independent analysis showing a case for restricting freedom of commerce in kiwifruit exporting?   Here is a challenge to Zespri and like-minded growers: if you think the arguments for the monopoly stack up, ask the government to seek advice on them from the New Zealand Productivity Commission when it is set up next year.  It is being established for exactly that kind of inquiry.