Tim Harcourt

In Australia the car industry is unique. It has unique Australian characteristics and capabilities, and its closure is a self-inflicted wound.
 
The exit of Toyota from Australia really symbolises the way the Australian economy has now moved on from the days when it was a manufacturer, and it now has more of a dependence on the resources sector.

Toyota has confirmed that it will cease all production in Australia by 2017. Approximately 2,500 jobs are expected to be lost when the Japanese car maker closes its Altona plant in Melbourne.

The exit of Toyota is very sad, and really signals the death knell of car making in Australia. In hindsight we should have focused on export orientation and trade promotion, supporting the free trade agreements, and building on our export success in Asia and the Middle East and emerging markets.

When I was on the Bracks Review, I made it clear the government could intervene with tariffs or support, but despite that changes in the global economy are had a huge impact Australian car industry. One crucial issue was until recently the very high Australian dollar which would have wiped out any impact of a tariff freeze and the protectionist lobby would have only had a pyrrhic victory of a few months.

However in the current debate over the future of the industry there are two extremes hogging the limelight. There’s one camp that says protect the industry no matter what the cost – and indeed protect manufacturing at whatever the cost – and there’s another camp that sees it as a badge of honour to say Australia should not produce cars and they belittle any outcomes by the industry to raise international competitiveness. I recall a former Australian ambassador in Washington, loudly and proudly telling an American audience that the optimal number or car companies in Australia is zero. Fortunately, Bracks, like Button before him, eschewed both extremes and advocated a moderate path of reform for the industry.

This steady reform is what we should have had; instead, we had Ford, GM, and now Toyota falling like dominos. If only GM had gone Ford & Toyota might have just hung on. Alas maintenance of manufacturing and the constant changing of promotional gears as global economic and environmental conditions change was very important.

Australia failed – and to hang out the car industry to dry is very sad.

Tim Harcourt is the JW Nevile Fellow in Economics and an adjunct professor in International Business Strategy, at the Australian School of Business, the University of New South Wales.

Tim Harcourt was also an economic adviser to the Bracks Review of Australia’s Automotive Industry.

Helen Hodgson

In an ideal (and economically efficient) world, tax policy would not influence the investment or consumption choices taxpayers make. In reality, this neutrality is rarely achieved.

External factors influence choices, which then fail to conform to rational economic models; or the tax system may be deliberately used to intervene in the market to counteract inefficiencies.

In Australia owner occupiers compete with investors for housing property; and there is also competition within these groups. A small increase in the number of superannuation funds and foreign investors purchasing property can have a significant impact on demand; while first home owners are finding it increasingly difficult to enter the market. Each of these groups is impacted differently by the tax system.

Owner occupiers are the major beneficiaries of tax concessions on housing.

The latest tax expenditure statement costed the Capital Gains Tax (CGT) exemptions on owner-occupied housing at A$30 billion, on a par with concessional taxation of superannuation at A$30.25 billion.

The Henry Review acknowledged that these tax expenditures can be justified as both contribute to people’s living standards in retirement.

However the CGT main residence exemption distorts the market as owner occupiers invest more in their residence, diverting capital from other more productive investments in the expectation of tax free capital gains.

Investors also benefit from the CGT discount, but negative gearing has a more immediate benefit. Negative gearing is the product of two of the basic design principles of our tax system.

Firstly, expenses are deducted from income in calculating the income or loss from an activity, and secondly we apply a global system under which income from all sources is aggregated to determine a taxpayer’s income for a year. Therefore, in the absence of any specific restrictions, losses from one activity can be applied to reduce the tax payable on income from other sources.

The tax statistics for the 2010-11 year show that 2.5 million rental property schedules were lodged by individuals, showing nearly A$30 billion of rental income received during the year.

The deductions claimed against this income amounted to A$37.8 billion, of which A$22 billion was interest on loans. A further A$1.8 billion was claimed as capital works deductions, which allows a write down for the capital cost of a building used to earn rental income.

There is no particular bias in the tax system to make negative gearing more beneficial for real estate than other investments: the drivers for that decision come from outside the tax system.

For example, lenders may be prepared to lend a higher proportion of the purchase price on real estate when compared to other forms of investment, thus the purchase can be more highly leveraged and the eventual capital gain will represent a higher return on funds invested. However this does presume the investor has the cash flow, often from other sources, to service the loan.

Negative gearing would be less attractive if the capital gain on the sale of an investment was taxed in full.

Negative gearing is a negative cash flow, but it produces an annual tax benefit that would be clawed back if the capital was taxed when the property is sold. But CGT is generally only paid on half of the capital gain as a discount is applied when calculating how much is included in taxable income. Therefore there is an asymmetry as the full amount of any mortgage interest is allowed as a deduction when incurred, but only half of the capital gain is included as income.

The Henry Review recommended (Recommendation 14) that a 40% discount should be applied across all forms of non-business investment income, including capital gains, with a corresponding reduction in the amount of interest that could be claimed each year. This would reduce both the bias to investments that produce capital gains over income, and the incentive to leverage off negative gearing deductions.

The group of prospective purchasers that is most affected by housing prices is notably absent from the discussion of tax incentives.

First home owners don’t have access to tax deductibility to subsidise interest payments, and without a windfall on the sale of another property they may have difficulty accumulating a deposit.

The effect of first home owner subsidies, however, is mixed: although it boosts the deposit the subsidy can itself be inflationary as vendor price expectations rise to take account of the subsidy.

The remaining group, renters, also face increased rents as the owners of rental properties seek a return on the capital they have invested in the property.

It has been argued that any changes to negative gearing would result in increased rents, based on rental increases between 1986 and 1988 when the Hawke Government quarantined negative gearing deductions. But this is largely discredited as the evidence shows there were other issues that increased demand in the Perth and Sydney markets over this time.

These current policies all affect demand, resulting in increased housing prices as investors and cashed up owner occupiers bid up the cost of housing.

What is needed is a set of policies that would stimulate the supply of housing, for example the National Rental Affordability Scheme which provides tax incentives on new housing development.

Ultimately tax reform in relation to housing will require the government to make some hard decisions.

The two issues that need to be reformed are the main residence CGT exemption and removing the ability to offset investment losses against other income. Such reform will not be successful without public support, and neither the Labor nor the new Coalition governments have been prepared to act on these proposals.

Helen Hodgson is a Senior Lecturer, School of Tax and Business Law at the Australian School of Business.  A version of this blog post appeared on The Conversation.

Geoffrey Garrett

Japan’s Prime Minister Shinzo Abe alarmed Tony Abbott and other world leaders at Davos last week by saying East Asia today reminds him of Europe in 1914. The new government has already been caught in the great power crossfire, with China’s bristling at its apparent pro-Japan, not to mention pro-America tilt.

Abbott’s overall stance is right. But to understand why requires thinking through Abe’s pre-1914 metaphor.

Like China and Japan today, Britain and Germany then were bound by large and mutually beneficial economic links. But win-win economic relations were not enough to stop the continent’s major powers descending into cataclysmic war.

With rising Sino-Japanese tensions in the East China Sea amid still raw historical animosities, is Asia on the edge of a major power confrontation that would inevitably suck other countries into a global war?

Military strategists in Australia and elsewhere are taking the risks very seriously, as they must.

Nonetheless, this nightmare scenario reminds highly unlikely for one: the transformation of America’s global role over the past century.

Put simply, the United States has the power and the interest dramatically to reduce the risk of war breaking out between China and Japan, and to isolate and minimize the consequences of any armed conflict should it ever occur.

China will continue to worry out loud that Australia is too close to the US. But make no mistake that the US remains the ultimate guarantor of peace and stability in East Asia.

Compare the worlds of 1914 and 2014.

Like prewar Britain-Germany, the fact that China and Japan are joined at the economic hip has not quelled high and rising tensions between the world’s second and third biggest economies.

But the global picture is completely different, and most of this has to do with the power and position of the United States.

In 1914, the US was an emerging economy three decades from global dominance. At least as important, America was a largely isolationist power that viewed internecine European wars as far beyond its concern.

More than a century after the revolutionary war, the bonds between Britain and the US had grown very strong. But no one was under any illusion that the US would immediately fight on Britain’s’ side. It clearly would not.

No surprise then that America sat idly on the sidelines of World War I until 1917 amid worries about a German invasion of the US from Mexico and the German sinking of an American ship in the Atlantic.

Also note that economic connections between America and Germany were minimal. The two were rival agricultural powers that had begun developing what would soon be awesome manufacturing might. But they were doing so in splendid isolation. America’s economy did not depend on Germany nor vice versa.

The US was simply disinterested in Europe. The contrast with America and East Asia today could not be greater.

It is an article of faith in the world’s largest economy that the US is the world’s “indispensible” power—there is no major issue in the world in which the US is not interested and for which the US is not needed to resolve.

The hurdle to US boots on the ground in the Middle East today is much higher than it was a decade ago. But Barack Obama’s “rebalance” towards Asia is very real.

Japan is one of America’s key allies, with a large, enduring and highly strategic US military footprint on Japanese soil. The US-Japan alliance would inevitably mean that the US would fight to defend Japan should it be attacked.

Doesn’t this make a doomsday World War III more likely? No, for two reasons

First, the US is not sitting idly by as Sino-Japanese tensions rise. America’s dominant and overpowering interest is in ensuring that armed conflict does not break out, and it is throwing all its diplomatic might behind this effort.

This does not mean that shots—likely accidental or unintended—will never ben fired across the East China Sea. But if they armed conflict occurs, the US will do everything in its power to ensure that the conflict is quickly defused and does not spread.

Second, the real game changer is the US-China economic relationship. Everyone knows about the strategic competition between the world’s top power and the only country that could take its perch.

But the Sino-American economic relationship is the deepest, most complex and biggest bilateral economic relationship in human history. This means China must consider much more than its antipathy for Japan while the US must think about much more than its Japan alliance.

America is China’s number one market, helping to lift hundreds of millions of Chinese out of rural poverty. Chinese government purchases of American Treasury bills keep US interest rates low and the post-GFC recovery strengthening.

For American multinational firms as diverse as Apple, General Motors and Wal-mart, China is not only their biggest supplier but also their biggest and fastest growing market. China in turn welcomes their presence because this gives aspiring Chinese global companies the invaluable chance to learn from and mimic the best.

China-Japan war is simply unthinkable for America, and it has the power in Beijing and Tokyo to make it highly implausible if not impossible.

Abe was narrowly right to draw parallels between China-Japan today and Britain-Germany in 1914. European economic ties did not stop World War I. But Japan’s Prime Minister missed the bigger and more important story at Davos.

A century ago the US was an emerging power happy to sit on the sidelines of European conflict. Today, it is completely enmeshed in East Asia. That remains the best possible news for Australia.

Geoffrey Garrett is dean of the Australian School of Business at UNSW Australia.

Follow Geoffrey Garrett on Twitter: @garrett_geoff .

This Opinion Piece previously appeared in the Singapore Straits Times.