2. Australian economic briefing by David Rumbens
This section of the briefing provides a snapshot of key contemporary economics data and issues.
Tax Discussion Paper
Over the past two weeks this briefing has highlighted the difficulties which will face Australia in achieving
meaningful growth in living standards going forward, in part because of our demographic destiny,
because we can’t rely on another China industrial boom, and further because we are already running
precariously high levels of household debt.
Sustained productivity growth is the key to delivering on growth in living standards, and an
important component of that productivity agenda could come from re-igniting competition (as detailed
in the recent Harper Competition Review). Further gains may come from the recent Energy White
Paper and the forthcoming review into the Federation.
Another major cog in this agenda could come from reforming the tax system, to build a more
stable tax base, and/or encourage a greater level of economic activity. The long awaited Tax
Discussion Paper re-starts the conversation around the relative merits of different taxes and the
effect of different taxes on economic growth and living standards.
At its core, the paper outlines the inherent trade off in any tax system between efficiency, equity and
simplicity – the three principles which underlie any tax system. The key question is how to raise the
required revenue to pay for government services in a fair way while doing the least harm to the
economy?
The paper shows how different taxes have different effects on these three principles. Generally, taxes
levied at high rates on narrow bases are more inefficient – they generate more cost for each
additional dollar of revenue raised.
Chart: Long-run modelling estimates of the marginal excess burden of some of Australia’s taxes
Source: Department of the Treasury
The chart above shows the estimated marginal excess burden (the loss of efficiency) of five major taxes
in Australia. It sets out the long-term cost for Australian household living standards for each additional
dollar of tax revenue raised.
Transaction and income taxes have the highest estimated cost for households as they have the
highest distortionary effect. That is through reduced incentives for companies to invest or for
individuals to look for additional paid work.
Consumption and land taxes have lower marginal excess burdens as they have smaller effects on
economic activity.
The Tax Discussion Paper also notes that around 58 cents from every dollar of tax raised in Australia is
from income taxes. This is considerably higher than the OECD average of around 35 cents from
every dollar and places Australia as second highest in the OECD on that measure (only behind
Denmark).
Shifting the balance from direct to indirect taxes could provide an efficiency dividend to the
economy, which would help contribute to rising living standards.
As Deloitte Partners Chris Richardson and David Watkins recently wrote in the Australian Financial
Review – “We already know Australia has a clutch of bad taxes. We know we have taxes so
inefficient they destroy a lot of value in the Australian economy for every dollar they raise; taxes with
narrow bases that raise small amounts of revenue, such as insurance taxes and taxes on luxury
goods. We also know we have taxes that have capricious impacts on fairness. And we know we
have far too many taxes; taxes that trip over each other and unnecessarily complicate the already all
too complex administration and compliance tasks required to run a business.”
3. Further they conclude that “Past white papers and reform efforts have already told us what the tax
reform road map looks like. We already know what to do….all Australians must pitch in and make a
start in debating how better taxes can deliver us a better future”.
Macro movements:
For the second month in a row, the Reserve Bank of Australia stared down financial markets betting on
a further interest rate cut when it left interest rates on hold at 2.25% last Tuesday. The RBA will need
to be on its mettle again next month with expectations now formed for a May rate cut. The perceived
benefit of another rate cut comes not so much from cheaper finance, but that it might send the $A
even lower to help support Australia’s tradeables sectors. The downside of course is further fuelling
asset price inflation, with investors continuing to drive the Sydney and Melbourne housing markets
higher.
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UK and International economic briefing by Ian Stewart
The UK's two-tier consumer economy
Consumer spending has long been a motor of UK economic activity. Growth in consumer spending
easily outpaced activity in the rest of the economy in the decades before the financial crisis. From
51% of GDP in 1977, consumer spending rose to account for 67% of GDP by 2009. The long
consumer boom was associated with declining levels of savings, rising indebtedness, buoyant house
prices – and widespread concern about the unbalanced nature of activity.
During the financial crisis consumers shunned debt and saved more. Real wages saw the longest and
sharpest fall since Victorian times. The consumer sector lagged behind the rest of the economy.
Today things are looking up for consumers.
Real incomes are recovering, helped by an upward drift in earnings and sharply lower food and energy
prices. Inflation dropped from 1.3% in October to a record low of 0.0% in February. Coupled with
good job growth, rising incomes have helped consumer spending to outpace activity in the wider
economy in the last
When UK consumers start spending the housing market generally joins in. Yet this time housing activity
has flagged as spending has accelerated. In February sales of residential property were 8% lower
than a year earlier.
A tightening of mortgage regulation by the Bank of England seems to have played a big role in
dampening housing activity.
In 2013 the Bank removed mortgages from the Funding for Lending Scheme which was originally
designed to boost lending to consumers and to companies. Last April the Mortgage Market Review
came into effect, putting additional checks on mortgage lending and, for some buyers, limiting the
availability of mortgages. And, in June, the Bank of England's Financial Policy Committee issued new
rules restricting the availability of high loan-to-value mortgages and requiring lenders to "stress test"
borrowers' ability to repay loans if mortgage rates rise.
These changes have squeezed mortgage supply, a process that has been reinforced by deteriorating
housing affordability.
According to the Nationwide building society, the ratio of house prices to first time buyers' incomes rose
from a low of 4.1 in 2009 to 5.0 at the end of last year, not far off the peak of 5.4 seen in 2007. In
London the house-price-to-income ratio stands at an all-time high of nine.
Pricier housing and tighter rules for mortgage borrowing have deterred would-be borrowers. The Bank of
England credit conditions survey shows that over the last three quarters consumer demand for
mortgages fell more quickly than during the crash in 2008.
This has created an unusual two-tier consumer economy.
On the one hand rising spending power and lower unemployment have driven a recovery in consumer
spending. Meanwhile housing activity has been crimped by tighter mortgage regulation and concerns
about housing affordability. The fact that in the last year unsecured consumer credit has expanded by
8.0% while mortgage borrowing rose by just 1.8% highlights the divide.
The Bank of England is probably pretty happy with this outcome. Last summer the housing market was
heading into boom territory. A cooling housing market represents a success for financial regulation
and removes one of the main reasons for early interest rate rises. With the consumer accounting for
two thirds of GDP the Bank needs consumers to spend to grow the economy. After a long squeeze
on households a recovery in consumer spending is probably seen by the Bank as being preferable to
another debt-driven housing boom.
4. So where does the housing market go from here? It is hard to see the Bank of England easing mortgage
regulation in a hurry. Meanwhile the General Election has created new uncertainties and the
possibility of tax rises for those on higher incomes and those with the most expensive houses.
Housing activity should get a boost from a recovery in real incomes and from lower fixed rate mortgage
deals. Interest rates on two year mortgages have fallen to an all-time low of just under 2.0%
according to the Bank of England. However, the standard variable rate, which applies to those at the
end of special or fixed mortgage deals, has crept up and, on average, stands at around 4.5%. Around
half of all mortgages are SVR. The obvious solution is to switch to a lower, fixed-rate mortgage deal.
But for some, at least, tougher regulations make that difficult or impossible.
Over the last year house prices have risen by 8.1% according to the Nationwide building society. Our
guess is that house price inflation will soften somewhat further, rising by around 6% in 2015 as a
whole.
MARKETS & NEWS:
The FTSE 100 ended the week up 4.06%, nearing record highs after a rebound in real-estate shares and a rise in
oil prices.
Here are some recent news stories that caught our eye as reflecting key economic themes:
Switzerland sold a benchmark 10-year government bond at a negative interest rate, the first time that
investors have been effectively charged for lending money to a government for such a prolonged
period
Mexico sold its first euro-denominated "century" bond at a yield of just 4.2%, marking the first ever 100-
year emerging markets bond sale in the European common currency
Investor sentiment in the euro area recorded its highest reading since August 2007, according to an
index of investor sentiment produced by Sentix
Americans' views on the US economy have reached an 8-year high according to a CNBC poll, with 27%
judging the economy as good or excellent
Greece's deputy finance minister said that Germany owes it nearly €279bn in reparations for the Nazi
occupation of the country, which includes repayment of forced loan and return of archaeological
treasure
Russian president Vladimir Putin and Greek prime minister Alexis Tsipras made a pledge to "restart and
revive" bilateral relations, in a perceived bid to boost each other's political bargaining position with the
EU
UK adults are prepared to pay a maximum of only 92p a month to access news websites, less than
email, search engines or online video, according to a YouGov survey
The governor of California ordered cities and towns in the drought-stricken state to cut their water usage
by 25%, although the order does not require cuts from farmers, who are the largest consumers of
California water
Data compiled by ING shows that the world's 15 largest emerging economies experienced their biggest
absolute capital outflow since the financial crisis in the second half of last year
Figures from London & Partners suggest that London-based digital groups received a record $682m in
venture funding in the first three months of 2015, up 66% compared with the same period last year.
The Wall Street Journal reports that digital-game developers hoping to qualify for new government tax
breaks in Britain now have to pass a "cultural test" to prove that their games are British enough
Discount retailer Aldi overtook Waitrose in sales this year, with half a million new shoppers visiting Aldi
so far in 2015
Whitbread, owner of Costa Coffee and Premier Inn, announced a big expansion of its training
programme with plans to take on 6,000 apprentices over the next five years
The New York Times reports that the proportion of 16-year-olds in the United States with drivers
licences has fallen to 28%, from 46% in 1983
McDonald's announced that it will raise the wages of roughly 90,000 employees in the US by at least $1
an hour more and allow staff to accrue more time off, amid a national debate over income inequality
A Lambert Energy Advisory report cited in the Sunday Times reports that 23 US shale oil producers,
pumping more than half a million barrels a day, have been pushed into deep losses by the halving of
the oil price.
Online cab-hailing firm Uber is to launch an auto rickshaw service in Delhi, India, allowing customers to
book the three-wheeled taxis via their Uber app
YouGov analysis suggests that people called Nigel are roughly twice as likely to vote for UKIP as the
general population. The name most associated with voting Conservative is Charlotte; Michelle is
strongly associated with voting Labour, Tim with voting Lib Dem, Jill with UKIP. The least
5. Conservative name is Clare, the least Labour one is Jonathan, the least Lib Dem one is June, and
the least UKIP one is Alex.
A UK train company has apologised after a train crew boarded a wrong train and took passengers back
in the direction they had come from, causing knock-on delays to other services – one track minds
