Dale Boccabella and Kathrin Bain

The tax “conversation” Treasurer Joe Hockey is hoping to kick off has quickly moved on to a discussion about the goods and services tax (GST).

Last month’s tax discussion paper reminded us that Australia’s GST rate of 10% is one of the lowest among developing countries, and only just more than half of the OECD average.

It may therefore be tempting for government to take the “easy” approach of increasing the GST rate, which would require less legislative change than making various changes to the GST base.

However, it’s imperative Australia fully debates the GST base broadening issue before reaching for the relatively simpler option of increasing the GST rate on the present base.

A rate increase on the present base would put us in (or at least move us towards) the same category as countries such as the UK, which have a relatively narrow GST base with high rates. It would also run counter to the widely accepted tax mantra of “broaden the base and lower the rate”.

For many reasons, a “narrow base, high-rate GST” is poor tax design. For example, the distortions to production and consumption decisions are magnified because of the greater difference(s) between the taxed and non-taxed items.

In addition, inequities are compounded based on consumers’ spending patterns. It would also put us on the path to replicating the discredited wholesale sales tax, which was replaced by the “superior” GST.

GST systems are designed to tax private final consumption expenditure (PFCE). But if only a portion of PFCE is taxed, the whole point of a consumption tax is significantly undermined or compromised.

In 2012, Australia’s GST applied to 47% of PFCE. This is lower than the OECD average of 55%. New Zealand’s GST is a stand out, with 96% of PFCE taxed; it is seen as a model to aspire to.

The big untaxed items in Australia’s GST are basic food, financial services (financial services have a nominal amount of tax on them), health, medicines, education, aged care, childcare and water and sewerage.

Each of these has its own reasons as to why they originally were not fully included in the GST base. The inclusion of all these items would move Australia well up into the 90% bracket of PFCE coverage, a very desirable position.

Basic food was excluded due to equity grounds. While health and education have a small equity aspect, the main reason was the challenge of dealing with both private providers (where there is a price signal) and public providers (where there is no price signal).

Given the differing rationales for the original exclusion of each category, it is very unlikely one policy measure (outside or inside the GST) can address all concerns. That means that significant broadening of the GST base is likely to require a number of targeted solutions.

However, the regressive effect of a flat-rate tax applying to more categories of PFCE is a recurring theme. When items are exempted from the GST base, all consumers, regardless of income level, receive the benefit of the exemption.

The tax discussion paper highlights that while lower-income households spend a higher percentage of their income on GST-exempt items, in dollar terms, it is higher-income households that receive the most benefit from GST exemptions.

For this reason, subject to the comment below, compensation through the direct transfer (social security) system is the best method of delivering compensation for the regressive effect of broadening the GST base, rather than dealing with the regressive effect through concessional treatment within the GST base.

The problem with compensation is that many voters (and many politicians) do not have faith in future governments maintaining the level of compensation over the long term.

This distrust was at the heart of the Australian Democrats insistence that basic food be excluded from the GST.

Perhaps the solution lies in a “lock-in mechanism”. There is no doubt the GST rate and base lock-in mechanism has been very effective as a political check on the federal parliament acting contrary to it.

This is in spite of the fact the lock-in mechanism is legally meaningless.

A lock-in compensation mechanism would necessarily be very different to the GST rate and base mechanism. It is very likely a compensation mechanism would not be legally effective because our federal parliament cannot generally bind future parliaments.

But given the political sensitivities around the GST and the categories of PFCE listed above, there is every reason to think that a lock-in compensation mechanism could be politically effective.

Dale Boccabella is an associate professor and Kathrin Bain is a lecturer in the school of taxation and business law at UNSW Business School. A version of this post appeared on The Conversation.

Peter Swan

Last Tuesday, Treasury announced in its discussion paper that the Abbott government was considering amending or abolishing Australia’s tax imputation system.

Since 1987, Australian taxpayers have only been taxed once on corporate income, not the double taxation that investors in many other countries have had to put up with (New Zealand, Chile and Mexico remain the exceptions).

Our franking credit-based tax system has undoubtedly given Australia one of the best and fairest systems of corporate taxation in the world, despite our still very high tax rates.

New Zealand, for example, with the same system as ours has maximum tax rates at about 33%, compared with ours in excess of 47%.

In the same discussion paper, Treasury reports that $19 billion in franking credits is distributed annually to Australian shareholders, with another $10bn paid to companies for future distribution.

Annual dividends to the value of $44.33bn, with grossed up value of $63.33bn, precisely generates the reported franking credits of $19bn at the notional value of 42.86c per dollar of franked dividends.

If the relevant taxpayer is in the modest 37% marginal tax bracket ($80,000-$180,000), the incremental tax presently paid is $23.43bn on this income. Hence, for such taxpayers, the cost over and above franking is about $4.43bn.

If double taxation were reintroduced, the after corporate tax dividend income on which personal tax would be payable is $44.33bn, yielding $16.4bn in incremental tax revenue.

Thus, the total paid on dividend income rises from $23.43bn to $35.4bn ($16.4bn plus the $19bn of cancelled credits) which is an increase in the tax take of 51%. The effective marginal tax rate on dividend income rises from 37% to 56%, a staggering rise of 19 percentile points.

If a person were receiving $100,000 a year in franked dividends and 37% is their marginal tax rate, they would be paying $37,000 per year in personal tax, leaving a modest after-tax dividend income of $63,000.

After the change, personal tax is levied on the $70,000 of after-corporate-tax income, leaving only $44,100 in after-tax dividend income as the marginal tax rate is still 56%.

If the investor is in the 47% marginal tax bracket the devastation is even worse. Their present after-tax dividend income is $53,000 and with the loss of the corporate tax rebate of $30,000 on the gross income of $100,000, their after-tax income falls to only $37,100. The increase in tax is $15,900.

Since their total tax paid is $62,900, the effective marginal rate has risen from 47% to 63%, comparable to France with the world’s highest tax rate on distributions.

In present value terms at the average corporate return of 12.77% per annum, since July 2001 this $19bn annual loss to local shareholders amounts to a decline in value of $148.79bn for franking shares worth approximately $500bn, a potential massive hit to stock values.

The discussion paper points out, correctly, that imputation encourages Australian investors to invest more in Australian stocks and less in foreign stocks than they otherwise would in a world in which inefficient double taxation of dividends is universal.

Given that information is vital for successful investment and that most information is local, the home bias means that both Australian firm and investor returns are higher when more Australians invest locally. Imputation, like aspirin, brings many benefits.

The discussion paper is keen to bring about more foreign investment in Australia by lowering the corporate tax rate. Under imputation, Australian investors gain no benefit from any lowering and, in general, imputation does little to encourage foreign investment.

Here the discussion paper is quite schizophrenic – while wanting more corporate investment in Australia, it would like to remove imputation as this would lower Australian investment in ourselves.

If any tax savings were used to lower the corporate tax rate such that the overall level of investment were preserved, all it would achieve is a worsening of Australian tax efficiency while making most Australian investors worse off.

Unfortunately for all those advocating a massive tax grab of $19bn, revenue gains would soon prove illusory. Australian companies would soon shift their corporate activities and tax base to tax havens. Imputation provides a strong motive to pay tax locally.

When imputation was introduced in 1987, there was a sizeable increase in dividends distributed so as to harness imputation credits. This would soon be reversed if the tax grab lobbyists have their way. Companies with poor investment prospects would invest more in a wasteful fashion, weakening Australia’s investment performance.

Imputation means there is no tax benefit from taking on more debt. Reduced gearing that occurred with the introduction of imputation would be replaced by sizeable gearing-up.

If there is no, or limited, equity capital, there will be no or negligible dividends, but highly indebted companies become much more susceptible to collapse during recessions. Abolishing overtaxed dividends is perfectly legal, and we all pay the costs of corporate collapse.

That $19bn tax grab is soon converted into an additional $19bn in wasteful activities, while the entire corporate sector takes a significant hit from which recovery would be difficult indeed.

Peter Swan is a professor of finance at UNSW Business School. A version of this post appeared in The Australian. All figures are in Australian dollars.

Richard Holden

Much will be written in the coming days about the turbulent political times in which Malcolm Fraser ascended to the prime ministership. But it is worth remembering that they were terribly turbulent economic times as well.

A simple chronology will note that Fraser’s prime ministership was wedged between the chaos of the Whitlam years and the seismic reforms of the Hawke-Keating era. But there’s more to Fraser’s economic legacy than that.

Fraser came to power amid a shocking economic occurrence: stagflation. Until the early 1970s it was thought by economists that high inflation and high unemployment could not occur at the same time.

This belief came from the prevailing Keynesian models of the era which posited a stable trade-off between inflation and unemployment. Rev the economy a bit faster and you got more employment and output but stoked inflation. Take the foot off the pedal and the opposite occurred.

But from 1973 onward this all changed. In 1975, inflation hit an alarming peak of 16%. In the decade that followed, Australia’s unemployment grew five-fold, spiking in 1982 as high as 10%.

At the same time, wages shot up, putting pressure on prices, which in turn put pressure on wages. This so-called wage-price-spiral was hard to break.

The Fraser government took a pragmatic, if not principled approach. Serious downward pressure was put on wages, but the spiral was never broken until the prices and income accord of the subsequent government.

Fraser’s “razor gang” cut back on commonwealth spending in a serious way — spending that was completely out of control under Whitlam. The Campbell report on financial reform – a watershed in Australian economic history – was commissioned, though not implemented.

Yet he didn’t go nearly as far as many members of his own government wanted in cutting back the role of the state and advancing free enterprise. The “dries” of the Liberal Party wanted a much more Thatcherite approach to the problems facing the Australian economy.

Yet Fraser resisted. He certainly pushed in a more free-market direction: government spending was cut, trade became more free, huge wage claims were curtailed. But he didn’t go all the way to Reagan’s “government is the problem” or Thatcher’s radical individualism.

In many ways Fraser approached the economy like a wise family doctor advising on dieting and weight loss: enjoy a little of everything, in moderation.

When Fraser became prime minister, the economic theory that would replace radical Keynesianism — the rational expectations revolution — was still being formulated and refined by Robert Lucas at the University of Chicago, along with others.

There was no clear path for what to do, and Fraser neatly steered a middle course. He did no harm to the patient, and laid the groundwork for the recovery to come.

In hindsight, could he have done better? Sure. His treasurer, John Howard, intimated as much in his recent interviews with News Corp columnist Janet Albrechtsen.

From my perspective we could have used a bit more Lucas and a lot less Keynes. More understanding of the virtues of competition and free trade. But Fraser lived economic events forward, without the benefit of hindsight, time to assess and reassess, and without the sophisticated number crunching that policy-makers have today.

Of course, Fraser’s legacy was arguably chiefly outside the economic sphere. Others will no doubt point to a variety of principled moral stands: against apartheid, for indigenous land rights, and in his post prime-ministerial years for a range of humanitarian causes.

Fraser was clearly a very decent human being.

But it would be wrong to think that he wasn’t also a good economic manager. In many ways he laid the groundwork for the Hawke-Keating years.

He certainly wasn’t a visionary like Keating, nor did major reforms take place on his watch. But he did steady the Australian economic ship for long enough that Keating had something to work with.

Australia can be justifiably proud of an approach to economics that is squarely between Europe and the US. The US, on the whole, champions free enterprise despite the social costs; Europe sees a much larger role for the state, even if that inhibits free enterprise. The Australia in which we live today is somewhere in between.

When Fraser became prime minister that was all up for grabs. We could have become “old Europe” or veered on to a radically individualist path in response to the debacle that came before.

Fraser helped us chart a middle course, and we should be very grateful for that.

Richard Holden is a professor of economics at UNSW Business School. A version of this post appeared on The Conversation.

Richard Holden

In the wake of the Queensland state election, and in the run-up to the election in NSW, privatisation is, once again, a hot topic.

Predictably, Labor is running a scare campaign that makes Henny Penny look like an optimist. If we privatise electricity distribution in NSW then not only will the sky fall in but the ground on which we walk will be in trouble, too. We will rue the day we deigned to discuss it.

The Liberal Party is no slouch in the scare stakes either: privatisation is so obviously right that we’ll tie building roads and basic infrastructure to it. No sell the poles and wires, no good stuff.

I’m not so sure.

There are sensible arguments on both sides of the privatisation debate. We just haven’t heard them yet. So here goes.

Most people would agree with the following statement: there are some things that government should pay for. National defence, primary and secondary education, basic healthcare – these are things that almost all of us acknowledge that government should pay for.

But what should government own? After all, we could give students (or their parents) a voucher for primary and secondary education. The same goes for healthcare. Just because government should pay for some stuff doesn’t mean they should own it.

After all, the government can outsource all sorts of functions to private-sector companies which face competitive pressure to do a good job at a low cost.

Yet sometimes government should not just pay for things, it should own them, too. Not often, but sometimes. And it’s useful to understand when and why.

The most insightful example is prisons – as Harvard economists Oliver Hart and Andrei Shleifer pointed out in 1997, along with Robert Vishny of the University of Chicago, in a now classic academic paper in the world’s oldest and most highly regarded economics journal: The Quarterly Journal of Economics.

Imagine privatising a prison. The downside of public ownership is that the warden who runs the prison has terribly weak incentives to cut costs and find efficiencies. He or she is just an employee, after all.

In contrast, private ownership will provide strong incentives for cost reduction because the private provider gets all the benefit of cost reductions.

But if quality – such as how prisoners are treated and what rehabilitation services are provided – is hard to describe in a contract, then these incentives might be too strong. Private prisons could cut costs by providing substandard treatment and insufficient rehabilitation services.

This is hard to dismiss as ivory-tower academic waffle. There’s plenty of evidence about how privatised prisons treat prisoners. And it ain’t pretty.

In a world of perfect foresight and perfect contracts none of this would matter. But in the real world there is a trade-off. Private ownership provides big incentives for cost cutting, but it typically comes at the expense of quality. Public ownership provides weak incentives across the board.

The key question is how hard it is to contract on what the government wants from a private provider.

The public debate that I listen to right now involves pretty silly arguments on both sides.

On the Left: “These are essential services” – subtext: “I wish the government could run everything, but we’ve lost that fight, and this is the last asset standing.”

On the Right: “Business is more efficient than government” – subtext: “I don’t trust public-sector-types to run a bath, let alone a $20 billion business.”

The key in all of this is that privatised entities will respond to incentives – they will cut costs. But experience teaches us that they will cut costs across the board, and there are some things we, as a society, want more rather than less of.

“Quality” and “innovation” are chief among those things.

So what about poles and wires in NSW? To make a serious case against privatisation requires pointing to big issues that the government cannot contract on in the process. It’s hard to see what those might be. This is a simple business with easily measurable outputs.

We all know what quality electricity provision means and the technology is well understood. Privatisation would provide incentives for cost reduction and free up much-needed capital for the state government.

Government should own things when, and only when, it is hard to describe what “quality provision” means and hence residual rights of control are important. Poles and wires in NSW is not such a case.

Both sides of politics would do well to drop the ideological pronouncements and get pragmatic.

Privatising these assets is neither “right” nor “wrong”. It’s just efficient and sensible. Like most things in life, it involves a trade-off. But this one is clear. The NSW government has no business being in the electricity business.

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

Richard Holden

If you want a recipe for a really bad public policy debate, combine the following ingredients: taxes, government spending, children’s welfare, gender equity and jobs.

However, there is one simple answer to the debate on childcare in Australia. Taxation.

The Productivity Commission has now delivered its long awaited report on the matter. Its answer? It’s all terribly complicated. According to the commission, we need sliding scales and means tests, carve outs and exemptions. It’s all a balancing act that can only be performed by a bureaucrat’s Excel spreadsheet.

I’m not convinced. It’s much simpler than that. Just make it tax deductible.

The reality is that childcare subsidies are not very complicated. We don’t need big, thick reports to get to the right answer. And we can do away with most of the agonised commentary as well.

So let’s take a deep breath and get back to first principles about childcare subsidies.

Why does the government subsidise some things and not others? Two reasons. The first is dignity. We believe that everyone who lives in Australia should have a basic level of human dignity.

So we provide a basic level of services for health, education, housing and other things. And so we should. It’s part of what makes Australia a great country. In some cases, this will also include the provision of childcare. For disadvantaged parents, affordable childcare can be essential to the ability to earn a basic living.

Existing policies on childcare also reflect this understanding, though rising costs may be putting access of this kind under pressure.

The second reason government subsidises things is because free markets – though great – don’t always get everything right. In the language of economics, sometimes there are “externalities”. Government subsidies are a way of “internalising” those externalities – a way of preserving the magic of the market, but getting the price signals right.

And so it is—or at least should be—with childcare. The market, left to its own devices, would provide too little and parents would consume too little childcare.

Why? There is a swathe of evidence – such as that from Nobel prize-winning economist Jim Heckman – that quality early childhood care has particularly large benefits for disadvantaged children.

Formal childcare can be essential to addressing the needs of disadvantaged children in ways that mean they also require less support from society later in life. This is the whole idea behind “head start” or early intervention.

Affordable childcare is also important to supporting job-market participation by parents, and particularly women. This has important gender-equity implications, which society as a whole should care about.

But it also has critical economic implications in terms of job-market participation and overall workforce productivity. Remember that G20 pledge Tony Abbott (correctly) made?

With taxes on income and a free market for childcare, parents rationally under-consume childcare. The playing field is tilted in favour of them doing more of it themselves because they are not taxed on the labour they provide in taking care of kids, but have to pay in after-tax dollars for market-based childcare.

Tax deductibility of childcare levels the economic playing field. Case closed.

There may be good arguments – based on dignity and the needs of disadvantaged children – for providing childcare subsidies. Those subsidies should also keep pace with changes in the costs and structure of the industry in ways that may warrant some form of government Excel spreadsheet.  But the key challenge on childcare is about economic participation.

In this context, we subsidise childcare not because it’s like healthcare, or a basic right, but because income taxes distort people’s decisions about how much time to spend at work versus at home.

Those  income taxes are vital for a whole range of reasons, but when they distort other decisions – such how much to give to charity – we fix it by making things tax deductible. And that’s precisely what we should do with childcare.

There is, of course, a complicated set of questions about who should provide childcare, and standards and accreditation. Sometimes, we might have good reason to want to insist that children be cared for in a formal setting: there are strong arguments for the educational and social benefits of formal daycare.

These benefits may also be especially important for disadvantaged or socially isolated children. In other contexts, we might think that parental flexibility, or individualised care, is more important.

But just because the government pays for (part of) something doesn’t mean they need to set up a separate agency to oversee how it is provided. In most cases, we think that parents are well placed to decide how best to spend any subsidy, or tax-deduction, they receive for childcare.

Anyone who has children knows that caring for them is a joy, a privilege, and a responsibility freely taken up. Work is also important. It gives people another sense of purpose, affords the dignity of providing for oneself and a family, and produces tax revenue for the government.

How to balance those things is perhaps the greatest challenge a working parent ever faces. The choices can be wrenching at times. But for government, the answer is simple:

Make childcare tax deductible. Provide a subsidy for those who earn below a certain income. Then stop.

Richard Holden is a professor of economics at UNSW Business School. Twitter: @profholden

James Morley

I am a member of the “shadow” Reserve Bank of Australia (RBA) board, which is made up of a collection of industry and academic economists. Just before every meeting of the real-world RBA board, we announce our recommendations for monetary policy.

Prior to the February meeting, we argued that RBA board members should hold the policy rate steady at 2.5%. But they cut the rate for the first time in 18 months to 2.25%. This was a surprise to many, including financial markets which responded with big gyrations in the dollar and equity prices.

So did we, like many others, simply get it wrong?

Not really, because a key distinction between the shadow board and many market commentators is that we are supposed to recommend what the RBA should do, not predict what it will do.

Of course we hope that the reasons behind our recommendation are so compelling that the RBA would come to the same conclusion, even if it does not directly follow our advice. So this distinction between what it should do and what it will do gets blurred somewhat in practice.

What to make of the RBA cut then? Did it make a mistake?

The short answer is “not exactly”. (I know, you’re thinking that’s a typical two-handed economist answer to a simple question. But I will explain.)

In my recommendation not to cut, I focused on the huge recent drop in oil prices. I argued that this contributed to a temporary decline in inflation below the RBA’s target range of 2% to 3%, with the latest CPI annual rate at 1.7%.

I acknowledged that low inflation provided some scope for the RBA to cut rates. But I suggested that the fall in oil prices, along with the fall in the dollar and robust growth in the US, would help broaden growth beyond interest-rate-sensitive sectors such as the housing market. So a cut could be delayed until the RBA had better prepared financial markets for one.

In the policy statement and the subsequently released minutes from its February meeting, the RBA actually covered a lot of similar ground, albeit in much more detail.

The big difference was the RBA emphasised that the unemployment rate would, according to its forecasts, peak at a higher level than previously thought. This change in the forecast was driven in part by revisions of GDP data which suggested weaker growth over the past year.

Given this new information and the RBA’s modelling of how it changes the forecast for the unemployment rate, an immediate cut in the policy rate was deemed to be the best course of action. Its concerns were subsequently confirmed by the latest unemployment rate data that showed a jump up to 6.4% in January, the highest rate in more than 12 years.

So the RBA looks prescient. At the same time, trying to prop up demand in a way that stimulates the housing market has its risks. The US experience in the early 2000s makes this abundantly clear. Ultimately, we won’t know whether the RBA made the right call for years, if ever.

The last shadow board recommendation wasn’t actually as simple as saying the RBA should hold rates steady. In general, we acknowledge uncertainty about the appropriate level for the policy rate by assigning probabilities to different possibilities. Think of this as like placing bets on what is the right thing to do.

Averaging across all of our members, we assigned a 68% probability that the appropriate policy was to hold steady, with a 13% probability for a cut and a 19% probability for a rise.

Importantly, we assign individual probabilities without conferring first. This is designed to avoid “group think” and there is a fair amount of variation in recommendations across members. (In February, I assigned 65% to holding steady, 20% to a cut, and 15% to a rise, which wasn’t too far off the average probabilities. The reasons for these probabilities can be discerned from my current and past written comments.)

Unfortunately for those who might enjoy a little controversy, we’re not in this to criticise the RBA.

This is in contrast to the original “shadow” Fed in the US, which was founded in the 1970s. It was quite critical of the Federal Reserve’s policy at the time, not just in terms of policy actions, but its whole policy framework.

Monetary policy has changed a lot since the 1970s, with the adaption throughout much of the world of the remarkably successful Kiwi export of inflation targeting. This policy framework emphasises transparency and a nominal anchor (that is, stable CPI inflation) that stands in stark contrast to the secretive and scattershot policies that were carried out in the 1970s.

The RBA has an inflation target and it is guided in its policy actions by forecasts of inflation and the unemployment rate. It explains in a transparent way why the policy rate is set at a given level, including how it will bring inflation within its 2% to 3% target range.

This framework has allowed the RBA to achieve very close to 2.5% inflation on average since the introduction of inflation targeting in 1994. So it is hard to be critical of the policy framework.

So what is the shadow board’s role then? I believe one answer is to provide some independent thought on monetary policy, including why it can sometimes make sense to raise rates, rather than cut them.

I’ve noticed a fairly unremitting enthusiasm in the financial press for rate cuts. And these do stimulate the economy, so why not? The answer, of course, is that these rate cuts can also lead to inflation and various imbalances that create long-run pain after the short-run gain.

At the same time, we need to avoid what Paul Krugman refers to as VSP (“very serious people”) syndrome, which leads to a constant and highly irresponsible call for short-run pain to somehow prove our economic virtue.

Despite such economic bloodletting being equally as bad as the long-discredited medical version, VSPs keep pushing their shockingly bad advice and sometimes even get to try it out with fiscal policy.

Monetary policy will always involve dilemmas with no easy solutions. A record low policy rate of 2.25% helps the Australian economy adjust to the end of the mining boom. But it almost certainly overstimulates the housing market, which will cause problems down the road.

The shadow board won’t provide a definitive answer as to what the RBA should do. We are clear about our own doubts. But we try to think through the possibilities in an objective way and hope to contribute to the public discourse on monetary policy.

Just don’t ask us to predict what the RBA will do at the next meeting.

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

Tim Harcourt

What an amazing time it’s been for Australia and India lately. With talks of a free trade agreement (on the coat tails of agreements with Korea, Japan and China), and “Modi mania” in Australia after the G20 as Indian Prime Minister Narendra Modi took Australia and the world by storm with his mandate to build a new India.

And then we saw India’s cricket fans, the “swami army”, swarming into the newly renovated Adelaide Oval for the historic India-Pakistan World Cup qualifier.

In fact, the India-Pakistan cricket match was beamed around the world and was estimated to have been the most-watched in the history of the game, in terms of TV viewers.

Also, Indian and Pakistani fans travelled to Adelaide, not only from South Asia but from Singapore, too, and some even came from as far away Toronto to be there for the first ball.

More than 80% of match attendees hailed from outside South Australia (SA) with large groups of Australia’s Indian and Pakistani communities making the journey across from Sydney and Melbourne. Indian and Pakistan flags were seen flapping from cars at the Victoria/SA border and Indian commentators thought Adelaide airport temporarily looked like any Indian airport in the middle of an Indian Premier League (IPL) series.

SA Premier Jay Weatherill hosted a key community function for Indian businesses on the Thursday before the match and a historic India-Pakistan business function was held at game. The game itself (which India won comfortably), had everything except the SA Tourism Minister catching a six, which he has done previously at Adelaide Oval.

The huge crowd in Adelaide is indicative of how the Cricket World Cup has been attracting cricket-lovers from near and far and of the related business opportunities, particularly in tourism. According to Cricket Australia’s Jonathan Rose: “Around 825,000 tickets have been sold and we expect to hit one million by mid tournament.”

Rose points out that even cricket newcomers such as Afghanistan played to a sold-out crowd in Canberra against Bangladesh (thanks to many of the Bangladeshi community in Sydney and Melbourne, who travelled to the game) and “that’s even before we count the Australia-England or South Africa-India blockbusters”.

As an economic moneyspinner the Cricket World Cup is growing, partially because the cost of broadcast rights has doubled for the International Cricket Council (ICC) due to the popularity of the game in India – especially the short forms of the game.

It is estimated that 70% of the world’s cricket revenue is generated from India and that’s why having the Indian team based in Adelaide was important to SA and why India is so influential in the ICC.

But how does the Cricket World Cup compare to other international sporting tournaments? It is estimated that it generates the equivalent of about 50% of the revenue the FIFA World Cup achieves, making association football/soccer truly the world game.

But cricket makes about 10-times the revenue generated from rugby union’s premier international tournament, the Rugby World Cup, which is being staged in the UK later this year.

In fact, the cricket-soccer comparison is important in the Australian context as both are local summer sports (given that Australia has three leading winter football sporting codes in Aussie rules, rugby league and rugby union) and Australia has just hosted a very successful soccer Asian Cup, which our Socceroos won in a thrilling final against South Korea.

According to Alison Hill of the AFC Asian Cup Local Organising Committee, the Australian community really took to the tournament as a whole, even in games where the Socceroos weren’t playing.

Hill estimates that “there were 650,446 match attendees, at an average of more than 20,326 [a game], with 380,000 attendees to matches that didn’t involve the Socceroos”. The TV audience was again massive with at least 315 million watching the tournament in China, Japan, South Korea, Australia and ASEAN nations alone.

So with the Asian Cup a success and the Cricket World Cup attracting fans globally to Australia and New Zealand, it’s a big year in the economics of international sport. And the associated benefits in tourism and marketing, not to mention “sports diplomacy” as exhibited by SA business hosting the India-Pakistan match at Adelaide Oval, shows it’s all much more than just a game on the world stage.

Tim Harcourt is the J.W. Nevile Fellow in Economics at UNSW Australia Business School and author of Trading Places and The Airport Economist.

Richard Holden

The great American baseball player, Yogi Berra, was reportedly once asked by his exasperated high school teacher: “Don’t you know anything?” He replied: “I don’t even suspect anything.” Clever.

I have always feared that for Prime Minister Tony Abbott, his grasp of economics can be similarly described, but without the witty repartee. It’s not beyond him but he doesn’t seem to care. It’s pretty obvious that he doesn’t know much about economics.

But that’s OK, I’m not sure Bob Hawke did either, and he presided over some of the greatest economic changes in Australia’s history. It’s the fact that Abbott doesn’t “suspect” anything, either; that may be his downfall.

Economics, for Abbott, is boring. According to people who know him well, he has no interest in the subject whatsoever. The funny thing is that people who knew the late Gough Whitlam well say strikingly similar things. He didn’t care about economics either.

Abbott moralises about matters economic. Debt is bad because of interest payments; companies should not get “corporate welfare”; we must live within our means.

I agree with several of the policy implications, but not because of morals, because of economics. Government shouldn’t subsidise bad car manufacturers because that’s a lousy way to try to create jobs. Government shouldn’t spend more than it earns except to stimulate the economy in very rare crisis moments. Debt is fine if it’s used for productive investment, but terrible if used for recurrent expenditure.

Abbott and Whitlam both became prime ministers in difficult and new economic times. For Whitlam it was “stagflation”: oil shocks, inflation, and the breakdown of the view that a Treasury department could control an economy like it was a remote-control car.

For Abbott it is “secular stagnation”. Former US Treasury secretary Larry Summers described it, aptly, this way: “In sum, I would suggest to you that the record of industrial countries over the last 15 years is profoundly discouraging as to the prospect of maintaining substantial growth with financial stability … changes in the structure of the economy have led to a significant shift in the natural balance between savings and investment, causing a decline in the equilibrium or normal real rate of interest that is associated with full employment.”

Whitlam failed, in no small part, because of his disregard for economics and his disrespect for the power of economic forces. Abbott is currently falling into the same trap. And if he doesn’t mend his ways, fast, he’ll end up in the uncomfortable place that Whitlam did – a casualty of economic forces.

Abbott is a likeable Prime Minister. He seems to have a greater love of this country than any political leader in my lifetime. He’s a good Burkean: cautious, prudent and appropriately skeptical of what government can achieve, but not contemptuous of government and the role it can play. He’s someone I would trust to take the “3am phone-call”.

But a good deal of what we need now is someone who can help us navigate the pressures of an ageing population; a tapering mining boom; and a relentless increase in global economic connectedness.

All of that means that, as things stand, government expenditures will grow at a much greater rate than government revenues. And that structural deficit problem, unchecked, will destroy the Australian social bargain.

This means that old-style tax bases are not up to the task. The stuff government does costs a lot more every year: medical technology gets better but more expensive, wage growth for skilled people is above inflation, the pool of people we provide benefits to is growing.

If Abbott does fail to hold on to the leadership I have little doubt that history will record it was economics that did him in. And if he succeeds, I suspect it will be because he finally persuaded Australians that if government expenses grow faster than government income for too long then disaster occurs. Economics 101.

Abbott explains that fact roughly like this: “We can’t pay ourselves more than we earn and piling up debt today is intergenerational theft.”

I’d put it like this. If tax receipts continue to grow at 3% a year and government expenditures continue to grow at 7% a year, then in 5 years our debt will be x% of GDP, in 10 years our debt will be y% of GDP, and in 20 years it will be z% of GDP.

Or perhaps like this: “Today we’re Australia, and we will be tomorrow. But if we don’t change our spending and taxing habits then basic arithmetic says that in 5 years we’ll be the US, in 10 years Italy, and in 15 years Greece. In 20 years we’ll be Paul Keating’s banana republic.”

Abbott may have ascended the prime ministership against the backdrop of a morality play. But the challenges we face are largely economic. Abbott needs to get that. And he should use a lot more of his considerable intellect worrying about economics, not morality.

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

Richard Holden

There continues to be a lot of discussion about the future of tertiary education in Australia. Should fees be deregulated, places capped, interest on student loans charged at the bond rate? And on, and on.

In all of this debate, however, there has been across-the-board praise for the HECS system, designed by economist Bruce Chapman and implemented by the Hawke-Keating government. And rightly so: it allows students to pay their share of the cost of their education over time, and do so contingent on income.

This does two things. First, it provides credit to students, thereby eliminating the need to have up-front cash to pay tuition fees. Second, it provides insurance against labour market risk. Loan payments are only due when a solid income is being earned.

All good, right? I sure thought so. Yet education policy scholar Peter Noonan recently said: “Anyone who thinks that a system that blunts price signals can simply underpin price deregulation doesn’t understand economics.”

Then University of Melbourne vice-chancellor Glyn Davis told The Australian: “HECS does blunt price signals but we don’t know whether it blunts them so much that it won’t work.”

Really? The argument seems to be that in a deregulated fee environment, an income-contingent loan (HECS) means prices aren’t as informative as in a market without HECS.

Well, I do understand economics and I beg to differ. In this market, HECS makes prices more informative, not less.

To see why let’s first be clear about just what a “price signal” is. The reason why people like me are fans of markets is because the market’s price mechanism has a remarkable ability to aggregate and communicate information. It can do what no central planner could ever hope to do.

My favourite story about how remarkable the price mechanism is in this regard comes from when I was living in Boston. I used to go to my local supermarket every day, and they had in-store-squeezed orange juice. One winter day, which seemed indistinguishable from the last, I noticed the price had more than doubled from $3.25 to $7.00. I also noticed an employee with a pricing gun changing the price of other juices in the refrigerator.

What had happened? It turned out that 18 hours earlier there had been a frost in Florida that had damaged orange trees, disrupting future supply. This had become known to traders, frozen concentrate orange juice prices had shot up, and local suppliers of oranges had raised their prices immediately in Boston. The supermarket manager, realising that in-store-squeezed juice and bottled juice were close substitutes raised the price of those, too. All in 18 hours — and all through markets.

So in a deregulated market for tertiary education in Australia, what would be the price and what information would it convey? The price, of course, would be the cost of tuition. A high price would suggest a valuable degree – perhaps because of field of study (such as, law or medicine), because of university reputation, or because of the quality of the education and educators. Right now prices are all essentially the same – so no price signal.

Different potential students have different information and perspectives on the value of those disciplines, universities, and faculties. The magic of the market is that the price of various degrees — in a deregulated market — aggregates and assembles all that dispersed information. This point was made forcefully by Austrian economist Friedrich Hayek in 1945 and was later formalised by the great American economist Sandy Grossman.

Now, there’s other information besides prices: rankings, word of mouth, ATAR cutoffs, and more. So prices wouldn’t be the only source of information in a deregulated tertiary education market, but still a very important one.

The key thing to understand in all of this is that most students are credit constrained. They don’t have accumulated cash to pay tuition up front. So they have to borrow. HECS allows them to do that on very generous terms. But suppose there was no HECS. What would happen?

Without the private loan market stepping in this would mean a whole host of students could not afford to pay for university. So they would not participate in the market. This would be terrible for them, but also terrible for the market. Their valuable information about the future would not be incorporated into the price for tertiary degrees and that would make even those who could afford to participate worse off.

The bottom line is that for markets to work well they need to be liquid — they need to have a lot of participants. The more liquid they are the better they are at aggregating and communicating information. When a huge chunk of people are credit constrained and can’t participate in the market that’s bad for them and bad for the market. Letting them in, as HECS does, sharpens the price signal.

Would it be sharper still without income contingent repayments? I think not. That would make students bear more labour market risk and drive more students out of the market for tertiary education. Both efficient risk-sharing and efficient credit-provision makes price signals better. And that’s precisely what HECS does.

The trap that Noonan and Davis have fallen in to is to think that because HECS makes students less responsive in their decisions to changes in prices it makes prices less informative. Not so.

It is an understandable mistake, for well-functioning markets do two things. They equate supply and demand, and they convey information. Both are pretty important. But it’s the latter that is what a price signal is really all about—particularly in a market such as that for tertiary education with dispersed information and a good deal of uncertainty about the future.

Hayek would have liked HECS. It helps, not hinders the market weave its magic. It makes the price mechanism work even better. It’s time to stop apologising for it.

Richard Holden is a professor of economics at UNSW Business School. A version of this post appeared on The Conversation.

Peter Swan

When Finance Minister Mathias Cormann said earlier this month that it was “unfair to rob our children and grandchildren of their opportunities to pay for today’s lifestyle”, he was attacked by economists from all sides of the political spectrum.

Research economist Warwick Smith wrote in The Guardian on January 9: “Repeat after me: the Australian economy is not like a household budget”, and said the Abbott government’s attempt to justify reining in budget deficits on these grounds is one of the “great myths of modern government financing”.

My friend and unreconstructed Keynesian economist Geoff Harcourt accuses the government, on the website The Conversation, of “deficit size fetishism” and denies the “supposed link between [deficits] and the welfare of future generations”.

My colleague Richard Holden denied in The Weekend Australian on January 10 that the national economy is like a household and said it was “misguided” to think that governments, like families, must live within their means.

The government’s difficult task is not helped by economists who believe that any restraint advocated by governments of a persuasion they may not like is pure ideology and that the clear and obvious analogy with household and family budgets has no relevance.

Popular radio personality Alan Jones tells his listeners that governments are subject to the same laws of economics, same resource scarcity, and same need not to waste the taxpayer’s scarce dollar as the families whose tax payments make government possible.

Have he and his listeners been conned, if not Cormanned?

Smith is convinced Jones and his listeners are wrong because “the federal government can create money”. Certainly, some governments have tried to pay their debts by printing money; Zimbabwe’s Robert Mugabe comes to mind. But so can individuals. Every household and family has a perfect legal right to create its own exclusive fiat money, Peter Swan banknotes.

In this sense, you and I are no different to Zimbabwe and Mugabe. My currency and his are rightly rejected as worthless, forcing Zimbabwe to use US dollar denominated currency, as does, effectively, Hong Kong.

The federal government does differ from you and me in one respect, though: it can and does pass laws making Australian banknotes legal tender.

Thus, domestic households have to accept Australian dollar denominated currency and if they purchase federal government debt denominated in Australian dollars they take the risk of its value being eroded by Australian governments when they create inflation.

Australians holding our wartime debt whose wealth was severely depleted by the inflation that occurred during the Korean War-inspired wool boom in the early 1950s experienced this.

Australia is a massive capital importing nation depending almost entirely on foreign rather than domestic savings to fund federal government deficits. These lenders are sufficiently sophisticated not to fall into the domestic inflation trap.

So, much of the borrowing is denominated in American or other global currencies, putting the federal government on a similar basis to the states. Queensland has already lost its AAA credit rating crown. Unless the federal government can balance the budget and pay down debt, it risks following suit.

Printing money simply devalues the Australian dollar, magnifying both the interest and the principal repayment burden.

Harcourt, however, believes it is a fallacy that the federal government needs to balance its budget over the economic cycle. Nor does he believe there is a problem with internal debt as it postpones the need for higher taxes, resulting only in the payment of more interest to Australian lenders.

This he regards as a transfer even though taxpayers and lenders need not be one and the same.

Harcourt believes there may be a case for foreign borrowing to pay for social infrastructure, even though he admits that higher exports will be required to repay the debt. However, this leaves us paying a rising international interest bill just to meet budget outlays into the indefinite future.

Holden argues that the analogy with household budgets is inappropriate because unlike mere mortals, governments live forever. He thinks that families “pay down that debt through prudent spending” only because they want to leave something to their children.

This does not obviate the need for governments to repay debt to prevent the interest burden paid by future generations blowing out beyond their diminishing capacity to pay, with the end of the baby boom generation, the ageing of the population, and collapse in our terms of trade.

Holden points out that “government doesn’t make stuff and it doesn’t create jobs or wealth”. I agree with this pro-market, anti-Keynesian sentiment. With properly enforced property rights in place the private sector can be left to provide social infrastructure such as hospitals and, presumably, toll roads.

The federal government does not need to incur ever-rising deficits and debt to provide law and order and enforce property rights. Hence Holden’s arguments seem to indicate a close analogy between government and household debt.

Both must be prudently managed and debt levels kept in check so as not to destroy the bequest motive (households) and to prevent interest payments alone absorbing the limited capacity to raise revenue (governments).

None of these three advocates for essentially unlimited public debt has in my estimation made the case, or even shown how it is possible, without a breakdown of society. The bailout crisis in Greece is a case in point. The analogy between government and household budgets remains intact.

Peter Swan is professor of finance at UNSW Business School. A version of this post appeared in The Australian.