Gordon Mackenzie

David Murray’s Financial System Inquiry (FSI) may call for the removal of superannuation tax breaks but the government’s tax discussion paper, due to be released next week, is unlikely to advocate similar changes.

The FSI report recommends articulating the overarching purpose of the superannuation system so that future tax changes can be measured against the objective.

It says the purpose of superannuation is to “provide income in retirement to substitute or supplement the age pension”. This then prescribes, in theory at least, the tax breaks individuals can get from the system.

In this case, the maximum tax break an individual should get from superannuation would be roughly equal to the net present value of the age pension paid from age 65 to the median life expectancy.

The age pension is designed to keep people out of poverty after they leave the workforce. Yet how does the inquiry’s definition of superannuation fit with financial planning theory which says that people need to aim for 70% of pre-retirement income to maintain their lifestyle?

It makes redundant any discussion about whether the current compulsory contribution limit of 9.25% provides an adequate retirement income. It also implies that superannuation should attract few tax breaks.

However, this raises the question of whether the tax system should be used to encourage saving, either through superannuation or outside it. There are four reasons why the tax system should not be used for this purpose.

First, the tax revenue forgone through the concession is borne by all taxpayers, while only those using the concession benefit from it.

Second and third, tax benefits only go to the wealthy who have disposable income to save and who have access to information to maximise the benefits of saving, such as accountants and lawyers.

Finally, tax concessions don’t increase savings, they just move preferences to where people save. But the reality is that they are used.

The report observes that superannuation tax breaks distort behaviour and favour the wealthy. However, a number of its observations will be difficult for the government to implement.

The inquiry report endorses Ken Henry’s tax review recommendation to reduce the tax benefits of popular negative gearing investing as well as the over-taxation of income from deposits. It also advocates that income from large superannuation balances should attract more tax, however this has a whiff of retrospective tax about it.

Another suggestion that post-tax contributions should be further limited is also unlikely to be adopted by the government. Few people use these concessions and they benefit empty nesters who are selling down to enjoy a hipster inner-city lifestyle rather than those trying to minimise their tax obligations.

The report says the system that taxes super earnings at 15% in the accumulation phase, but not in the retirement phase, leads to asset allocation distortions, tax arbitrage and prevents funds offering “whole-of-life” financial products. However, it is doubtful whether any of these problems are tangible and important enough to warrant changing the system.

Finally, the report suggests removing the company share dividend imputation system and reviewing the capital gains tax discount. Interestingly, the report argues these incentives distort asset allocation yet both these measures were introduced with the intention of removing tax distortions.

Imputation credits were introduced to lower the cost of capital towards equity rather than debt funding. The capital gains tax discount was introduced to prevent the over-taxation that potentially arises from capital gains all being taxed in one year leading to higher marginal tax rates.

However, the report’s focus on changing interest withholding tax on foreign lending institutions should be addressed. This tax distorts the funding decisions of financial institutions and places Australia at an international competitive disadvantage. If it has to be paid then almost invariably it will be paid by the Australian borrower, not the foreign lender, so it just raises the cost of capital with little revenue to be gained

Should these tax observations be included in the tax issues paper? They seem to warrant considered discussion but with two overarching caveats.

First, superannuation is a very long-term savings vehicle and changes reduces confidence in the system.

Second, savings in the system are there based on the good faith continuance of existing tax laws. In the past 35 years, there have been only minor changes that adversely affected existing superannuation account balances.

However, the chances of the government implementing these tax changes is slight.

Though Treasurer Joe Hockey backed the report’s recommendations to lower fees for super funds, it is unlikely that many of the report’s observations in terms of tax will go ahead.

Adverse changes to the superannuation system are off the table for the first term of this government, apparently. If superannuation tax breaks are measured against the age pension, a significant proportion of the population will be adversely affected.

Changes to capital gains tax are also unlikely to go ahead as most countries differentiate between regular income and capital gains. What remains is imputation credits for company dividends. Adverse changes here would be politically unwise as they are very popular among mum and dad investors and super funds.

Gordon Mackenzie is a senior lecturer at UNSW Business School. A version of this post appeared on The Conversation.

Richard Holden

David Murray’s Financial System Inquiry makes a long list of thoughtful recommendations. But as an economist reading through the report, I tried to find a unifying theme. Why do they recommend this and not that?

I finally concluded that there isn’t a unifying theme. There’s a lot of careful issue-by-issue cost-benefit analysis. But not having a coherent framework for thinking about all the interconnected issues leads to some missed opportunities, and some flat-out unforced errors. That’s a shame. And nowhere is that more evident than in the inquiry’s tax recommendations.

If you’ve made it to, and through, Appendix 2 of the report you will know that the inquiry raises the possibility of a number of tax changes. Dividend imputation, concessional capital gains tax rates, negative gearing, and even charging GST on financial services are all raised as candidates for change.

In many ways the inquiry seems to be channelling what one far too frequently reads in the press: “the housing market is out of control so stop negative gearing”.

I don’t know whether there is a housing bubble in (insert your favourite capital city) and I wouldn’t know how to tell even if there was one. Have people got caught up in modern-day tulip mania or have they just realised that Sydney is a great city? No sensible economist is willing to take a strong stance on this.

But let’s suppose, for the sake of argument, that there is a housing bubble. What should we do about it? The very last thing we should do is fiddle around with tax policy that fundamentally tries to put all asset classes on a level playing field.

Good tax policy is emphatically not about encouraging a little bit more of this or a little bit less of that. Good tax policy is about making distortions as small as possible, sending the right price signal, and getting out of the way of the market.

The inquiry’s stance on dividend imputation is particularly telling in this regard. The report states: “The case for retaining dividend imputation is less clear than in the past . . . the benefits of dividend imputation, particularly in lowering the cost of capital, may have declined as Australia’s economy has become more open and connected to global capital markets. If global capital markets set the (risk-adjusted) cost of funding, then dividend imputation acts as a subsidy to domestic equity holders. That would create a bias for domestic investors, including superannuation funds, to invest in domestic equities.”

For Murray, it seems, this is all a complex set of trade-offs that need to be monitored and tweaked. Don’t we just need a sound review of these arrangements every 10 to 20 years, rejig how hard our foot is on the accelerator versus the brake, and all will be OK?

Actually, no.

Double taxation of corporate profits made no sense – and it encouraged firms to take on more debt than they otherwise would. The Hawke-Keating government realised this and introduced dividend imputation in 1987. Good economics and good policy. Case closed.

Yet Murray is now concerned about how much super funds invest in domestic versus foreign equities. That may (or may not) be a legitimate concern, but dividend imputation is the last tool that should be used to address it. Dividend imputation eliminated a non-level playing field and the distortions that came with it. Leave it alone.

The same logic applies to a range of other taxes that Murray puts on the table. Negative gearing just treats housing like any other investment. Concessional superannuation tax rates combat the problem that people don’t otherwise save enough for their retirement and then turn to the government for help. When national savings are too low it raises interest rates for everyone. Concessional tax rates for saving are completely sensible against this backdrop. As economists say “it internalises the externality”.

The inquiry contains a lot of thoughtful and well-informed suggestions. But it falls into a classic trap. It wants to tinker and fine tune. It is authored by someone who was a very fine manager of a very large and important business. And, alas, it shows. Murray, and his report, wants to manage. But good “system design” is not like good management – and it’s not like being a central banker.

Poor old Glenn Stevens has one instrument – the cash rate – to manage a host of issues: inflation, unemployment, the exchange rate, and housing prices. Murray and, more importantly, Treasurer Joe Hockey do not face such constraints. They have a whole host of tools at their disposal and can use the right one to target each problem.

What should happen, in taxation arrangements and elsewhere in the financial system, is that the market should be given non-distorting price signals. Nothing less, and nothing more. And when thinking about tax arrangements in this coming year the debate should be about how we tax, not who we tax.

Richard Holden is a professor of economics at UNSW Business School. A version of this post appeared in The Australian Financial Review.

James Morley

A recent internet meme making the rounds on Facebook compares minimum wages and the prices of Big Macs in the US and Australia. The minimum wage is more than double in Australia (A$16.87 an hour versus US$7.25 an hour in the US), while the price of a Big Mac is about the same in both countries.

Despite the much higher minimum wage in Australia, unemployment rates in both countries are around 6% and the Australian unemployment rate remained at this lower level in recent years, while the US suffered from double-digit unemployment at the height of the Great Recession (the global financial crisis and its aftermath).

If the minimum wage appears to have little impact on the unemployment rate or prices (though other restaurant prices are noticeably higher in Australia, as any tourist will tell you in about 10 minutes upon their arrival in Oz), why are economists generally opposed to mandating a “living wage” to reduce income inequality?

Non-economists might assume the answer is simple: economists are pro-business. But we’re not. We’re pro-market, not pro-business.

The possibly surprising reason economists tend to oppose a “living wage” is virtue. In particular, if the goal is to reduce inequality, mandating someone else to pay a higher wage is not a particularly virtuous way to do this.

This is because it prevents an employer and potential employees from engaging in mutually beneficial exchange. At least this is how I saw it as a teenager in Canada struggling to find a summer job during a recession. My frustration with the minimum wage policy was one of the reasons I became an economist later in life.

In typical teenage fashion, I indulged in reductio ad absurdum arguments at the time, wondering why proponents of a “living wage” kept such earthly ambitions. If they truly thought such a policy would have few unintended consequences, why didn’t they propose mandating a “heavenly wage” that would allow all of us to drive Porsches through the pearly gates?

My cynicism was mostly incited by the fact that minimum wage and living wage laws cost politicians nothing (except possibly votes from small business owners). I detected a distinct lack of virtue in a costless mandate from government about what wage a high school student could work for.

If progressive politicians really wanted to be more virtuous in helping the poor and reducing income inequality, they should do something that would no doubt be very hard for them. They should listen to Milton Friedman.

Friedman, of course, opposed minimum wages because they hindered the proper functioning of markets. Instead, he argued for a guaranteed minimum income, whereby everyone (man, woman, and child) would receive a lump-sum income payment to cover basic needs (in practice, he argued for implementation of the program in the form of a negative income tax).

Because it does not restrict mutually beneficial exchange or create disincentives to work, a guaranteed minimum income is less distortionary than a minimum wage or a welfare program.

Like a welfare program, a guaranteed minimum income is costly, which is its source of virtue, but a hindrance to implementation. Friedman opposed means testing to limit who qualifies for the income payment, though a means test is probably the only way to make such a program financially viable.

However, a graduated means test could reduce the disincentives to work compared to a sudden threshold and make the program more affordable. And, in general, any increase in focus on income rather than employment status would be an improvement over most existing welfare programs in term of incentives to work.

I’ve mellowed since my teenage years in terms of my views about minimum wages (though not about “living wages”). Having also lived in the US and Australia, I can now see the problems with a very low minimum wage and some benefits of a higher minimum wage.

For example, in the US, service workers often receive tips in addition to their minimum wage (tipping is much less common in Australia). But they would clearly be better off receiving their compensation and benefits all in one payment, as they do in Australia.

And minimum wages may simply be much more politically feasible than a guaranteed minimum income, with or without means testing. As a wise friend once told me, we should never let the best be the enemy of the good.

At the same time, I recognize the typical hypocrisy of middle age in my mellowing views. Compared with when I was younger, I can now sometimes afford the higher restaurant prices in Australia. And youth unemployment in Australia is quite high and has been increasing relative to the rest of the population in recent years. It is hard to believe this is completely unrelated to a minimum wage that is close to A$20 an hour in many service industries.

Ultimately, though, I think economists of all political stripes (even Friedrich von Hayek professed to be in favour of a guaranteed minimum income) have it right that the focus in addressing income inequality should be more on progressive taxes and less on a “living wage”.

James Morley is a professor of economics and an associate dean at UNSW Business School. A version of this post appeared on The Conversation.

Renée Adams

There is a popular notion that women are not risk takers and their mere presence on a bank board will reduce risky strategies and behaviour.

During the past few years there has been an increasing trend of female directors on company boards. A leading factor has been the introduction of gender diversity policies. Already women hold 23% of directorships in the UK’s top companies, just shy of the government’s target of 25% by 2015.

According to the Australian Institute of Company Directors, at the end of August this year, 18.3% of top 200 ASX company board directors were women.

Among the Big Four banks, the ratio ranges from two women on a board of 12 for NAB, to four women on a board of nine for Westpac. On the Reserve Bank of Australia board, three of the nine directors are women.

Does this mean our banks, by virtue of this trend, are falling into an increasingly safe pair of hands?

The safety factor concept has been used in the past to support the argument for gender quotas for boards. Some of the world’s leading economic spokeswomen (and men) have very publicly argued women are “typically” more risk-averse and therefore their presence on boards helps contain risky behaviour.

This premise led to what became known as the “Lehman Sisters” hypothesis, which arose in the years following the global financial crisis. The theory was if Lehman Brothers had been Lehman Sisters (or brothers and sisters), there would have been no collapse

Sadly for those who believe banks revel in the occasional risky business, adding more women to the board is unlikely to have an impact.

In a research paper I co-authored with the University of Queensland’s Vanitha Ragunathan, we showed that more women on boards will not lead to less risk in banks.

Women who choose to follow a career path leading to a directorship are not the “typical” woman in risk-aversion studies. Instead, female directors are likely to be less risk-averse than the “typical” woman because of selection. That is, they would not have chosen this career path if they were so risk-averse.

Selection is likely to be even more important for financial firms because finance is a business dealing with risk. Women in finance may well have the same average levels of risk aversion as men in finance.

Our research showed that female MBA students who choose to enter finance after graduating are much less risk-averse than female MBA students not entering finance. In fact, female MBA students in finance are less risk-averse than male MBA students in finance.

The research shows the dangers of stereotyping women. Applying gender differences that may occur within the population to the management level does not work.

However, though having a greater proportion of women on bank boards may not reduce risk, it does provide other benefits.

Our study reviewed around 300 large publicly traded US banks and bank holding companies across a four-year period spanning the 2007-2008 financial crisis. We found that US banks with more women on their boards were not less risky during this period. However, they did perform better during the financial crisis.

Male directors on boards with more women have fewer attendance problems. Female directors also tend to perform different committee duties than male directors.

Women are more likely to sit on board committees, especially those with key monitoring duties such as auditing or corporate governance. However, they are not more likely to sit on banks’ risk committees. Banks themselves seem to not view their female directors as being more or less prone to avoiding risks than their male directors.

We still do not have a complete understanding of how and why gender diversity matters for corporate outcomes. We also do not know when diversity matters. However, the concept of using women on bank boards as a quick fix for bad corporate behaviour is simplistic and devalues the other benefits that diversity brings.

Renée Adams is a professor and Commonwealth Bank Chair in Finance at UNSW Business School. A version of this post appeared on The Conversation.