Richard Holden

In the lead-up to Australia’s federal budget on May 13, there have been the usual test balloons floated by the government. Raise the aged-pension eligibility age? A $6 co-pay for GP visits? Cuts to the ABC? And so on.

But the prize for the most “interesting”— and I mean that in the ancient Chinese curse kind of way — is the idea of a “debt levy”.

It’s a little hard to tell exactly what the idea entails since neither the Treasurer nor the Prime Minister will really talk about it, but it seems to be simple enough. Tax those Australians earning over a certain income level a special “one-off” amount and use the proceeds to pay down government debt.

Just like the flood levy and the East Timor levy, right? Actually, no.

The flood and East Timor levies were one-off responses to unusual budgetary shocks — one a natural disaster and the other a geopolitical necessity. They made sense because they dealt with transient fiscal problems. But structural problems require structural solutions— not one-time levies.

When your local surf club has a fire not covered by insurance, it makes sense, painful though it may be, for the members to kick in for the repairs. When the committee says they need a special levy to pay for recurring expenses like petrol for the inflatable rescue boat, there’s a change of committee at the next annual general meeting.

Labor’s response to the proposed levy is as revealing as it is disconcerting. Shadow treasurer Chris Bowen has barely stopped for air in repeating the line: “But they said they wouldn’t raise taxes.” Really, Mr Bowen? That’s your problem with it? You’re OK with bad policy if it’s announced in advance?

I do give the shadow treasurer partial credit for borrowing a line from Ferris Bueller’s Day Off — but he missed the real voodoo in the government’s economics.

First, Australia does not have a debt crisis. Or, to put it another way, Australia does not have a debt crisis. Far from it. Commonwealth net debt is about 11% of GDP, the third lowest in the OECD (the average is 50%), and low by historical standards. Government borrowing rates are at all time lows. Indeed, it was only a few years ago that we were discussing how Australia’s debt being so low was a serious problem because it might lead to the government bond market drying up.

But isn’t all debt bad? I mean, shouldn’t the country live within its means and not spend more than it “earns”?

As Nobel Laureate and New York Times columnist Paul Krugman has pointed out repeatedly: government finances are fundamentally not like personal finances, for multiple reasons. One of them is the huge payback that social investments can deliver.

Government debt levels should typically not be zero. The Commonwealth government can borrow long term at around 5%. The social returns on wise social and infrastructure investments are often more than 15%. Not borrowing at 5% and lending at 15% is to miss huge opportunities.

Governments can invest in projects that we never can as individuals: healthcare, schools, major infrastructure, national defence — and that’s what makes the large returns possible. It is just very different than thinking about maxing out your Visa card to go skiing.

But suppose you don’t believe any of that. The debt levy is still a bad idea. It won’t raise very much money, and it will set a terrible precedent.

Suppose there is a 1% levy on all incomes over A$105,000, for one year — that is, the top 10% of tax payers. This would, by my back-of-the-envelope calculation, yield about $1.9 billion in revenue, all else being equal. That would reduce federal government debt by about three-quarters of 1%. That’s basically a rounding error in the scheme of things. So is it going to be bigger, longer, apply to more tax payers? It gets you thinking …

And there’s the “all else being equal” part, so often overlooked in public discussions about taxes. If announced for the coming year, workers will rationally adjust the amount they work, hence earn, and hence pay in taxes. Economists of all stripes know that labour supply adjusts to taxes. The result would be not only less revenue than might naively be predicted, but slower growth and private spending as well.

Of course, it could be made to apply retroactively to avoid the labour supply issue. And this brings us to precedent. In this respect a debt levy would be truly disastrous.

If it becomes acceptable for governments to simply jack up taxes because they don’t approve of the policies of the previous government, then public confidence will be shaken. It will create a climate of fear and uncertainty that will deter investment in physical and human capital — with potentially severe economic consequences.

One should feel a bit for Hockey. He has got a really bad job. This budget won’t please many people, and it will entail some tricky politics. But it can, at least, be good, grounded in good economics.

When it comes to the debt levy the Treasurer should heed the Reagan mantra. Nancy Reagan, that is, and “Just Say No!”

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

Dale Boccabella

In the lead-up to Australia’s crucial federal budget in May, it could be argued that requiring the National Commission of Audit to identify revenue trends that could pose a risk to the budget’s structural integrity could encompass tax expenditures.

While the commission’s terms of reference expressly mention levels of direct government expenditure, such as grants and transfer payments, there is no express reference to tax expenditures and secretariat Peter Crone has confirmed that it will not deal with them.

Tax expenditures are “expenditure programs” of the Commonwealth that are delivered through the tax system, rather than the direct expenditure side of the budget. They mainly take the form of deductions, rebates, exemptions and concessional valuation rules.

The essence of tax expenditures is that they involve under-taxation compared to the nation’s benchmark income tax system. What the benchmark should be within our income tax is debatable, so not everyone will agree with Treasury’s view on that. Treasury mainly works with the idea that most gains and profits should be fully taxed under a benchmark system, and that is why tax-free gains made on the sale of family homes is listed as a very large tax expenditure.

On the other hand, the generous tax treatment of discretionary trusts (family trusts) is not included in the tax expenditure statement – but there are good reasons why it should be. The negative gearing loss on rental properties and share investments is not included either. For 2012-13, the Commonwealth has around 280 tax expenditures under the income tax, worth around A$100 billion. This is around 6% of GDP. Direct expenditure of the Commonwealth for the same period was around A$360 billion, which is about 24% of GDP.

The point is that tax expenditures are significant in size. While characterising tax expenditures is problematic, they deliver concrete economic advantages and, in numerous cases, significant advantages to their recipients in the form of deliberate non-collection of taxation.

Given this, why aren’t tax expenditures expressly within the terms of reference of the commission? After all, keeping tax expenditures out of the its deliberations necessarily means it is not looking at all government expenditure items.

Does this matter? Yes, because any deliberations and ensuing recommendations may not be based on full information. If the commission will not examine the full scale of government assistance being received by a sector or a category of taxpayer, how can a credible recommendation be made about the level of direct assistance that should be scaled back?

Attaining the goals of fairness, equity and efficiency through our public finance system dictates that all the main value exchanges between a sector or taxpayer grouping and government should be taken into account when determining whether the current level of “expenditure” is appropriate.

A good example is housing, where there are both substantial direct payments provided to taxpayers (such as housing grants and rental assistance) and considerable tax expenditures (such as negative gearing). How can the commission make fair and efficient recommendations about the proper level of rent assistance and pensions in the direct expenditure system when it does not consider the level of assistance provided to homeowners and others through tax expenditures? There are many more examples in both the private and business sphere.

The commission’s response is that tax expenditures will be taken into account in the tax review, promised by Treasurer Joe Hockey. The problem with this is that direct expenditures are hardly ever comprehensively examined in tax reviews, which means the same partial or disjointed examination problem is present again. Further, the tax review and associated measures are some way off, whereas the 2014 budget is just months away.

It is hard to predict what the political landscape will be in three to four years time. Indeed, given the risk of an inevitable voter disenchantment following any savage budget cuts, it is very unlikely that the government will have the same reserves of political capital to move on tax expenditures with a similar degree of vigour that will be brought to bear on direct expenditures.

In any event, the directive in the commission’s terms of reference to aim for savings that will deliver a surplus of 1% by 2023-24 is a strong indication the government intends for savings to mainly come from reducing direct expenditures, and not reducing tax expenditures.

Yet the problems of not dealing with tax expenditures are compounded because the political dynamics are quite different between examinations of direct expenditure programs and tax measures.

What can happen is that the proposed removal of a tax expenditure can easily be seen and presented as a tax increase. The failed attempt to remove the tax expenditure on the car fringe benefits tax in the lead-up to the 2013 election is a recent case in point.

The “age of entitlement is over” doctrine outlined by Hockey implies that before entitlements are reduced (or less likely, increased), a fairly accurate account of the level and spread of entitlements will be established.

It is hard to see how such accuracy can be attained if tax expenditures are not subjected to the same standard of scrutiny and the same political accountability mechanisms that are applied to direct expenditures.

Dale Boccabella is an associate professor in the School of Business Law and Taxation at the Australian School of Business. A version of this post appeared on The Conversation.

Dale Boccabella

The push from the states to reduce the GST threshold on imported goods is being driven by a desire for a bigger pool of GST revenue and they will get their way, despite the inevitable backlash from consumers.

Australia’s $1,000 GST low value exemption on imported goods is significantly higher than comparable countries such as the UK ($25), Canada ($20), Singapore ($330) or New Zealand ($320). More importantly, the $1,000 threshold is too great a departure from the zero-threshold that applies to consumer purchases from Australian bricks and mortar retailers.

What may further anger consumers is the approach governments take to border security charges and tax collection costs under a lower threshold, given that parcels flowing through the international mail stream into Australia are subject to manual, labour-intensive processes.

Under current law, there are no Customs and Border Protection import charges levied on imported items valued at or below the $1,000 threshold. However, somewhere between $40 and $48 is charged to goods above $1,000. Also, the Department of Agriculture, Fisheries and Forestry levies a $15 charge on items above $1,000 to support its biosecurity obligations.

Julian Lorkin interviews Dale Boccabella from UNSW about the push to reduce the GST threshold on imported goods.

As the 2012 report from the Low Value Parcel Processing Taskforce noted, the present approach to border charges involves cross-subsidies, infringes neutrality and undermines the government’s cost recovery principles. Accordingly, if the government decides to lower the GST threshold (to, say, $300), it will be faced with the decision as to the level of charges (if any) that will apply to the import.

In addition, GST collection costs for the newly taxed items are very likely to be passed on to consumers. The most likely outcome is that the express carriers and Australia Post will be required to collect and remit GST to Customs, and from there, be allowed to recoup these costs from the consumer.

Part of the reason for placing this burden on the express carriers and Australia Post is that goods can be released to consumers from Customs-controlled premises before the GST is collected, thereby allowing for quicker delivery. This would also avoid the need to store “tax unpaid goods” at mail gateways and licensed premises, which already have significant capacity problems.

All up then, a consumer who purchases a $500 item from an overseas supplier could end up paying a lot more – say, $650-$750 – to actually obtain the item. The cost will be even higher if GST is levied on transport and insurance costs, which is currently the case for goods above $1,000.

The question of whether the lower threshold would also apply to customs duty will also need to be addressed, but this would not be a significant cost as most items only have 5% duty on them.

The other political issue involves the timing of a change to a lower threshold. On the one hand, the bricks and mortar retailers and the states would prefer a lower (permanent) threshold implemented as soon as practically possible. But border security agencies such as Customs, as well as the express carriers and Australia Post, would like anywhere between 18 months to three years to implement it properly.

Timing will depend on the time required to upgrade computer systems, and increasing staff numbers to deal with the higher volume requiring manual data capture in the international mail stream, as well as required staffing changes to deal with increased volumes of items requiring GST assessment and collection.

The movement of cargo was severely disrupted and border security compromised during a two-month period when the import component of the Integrated Cargo System was introduced by Customs in 2005. This happened due to the lack of pre-testing of new systems and software, a lack of industry readiness and training, and lack of staged implementation of the change. The government will want to avoid repeating such a failure.

The Taskforce noted three things. First, it would not be practical to just lower the threshold without any system changes and considerable preparation. Second, depending on issues such as who will collect the GST from the Australian consumer – there are a number of options, or a combination of options – and the extent of system changes required, initial reforms could be implemented within two years.

Third, once a decision is made to lower the threshold, reductions in the threshold to its long-term level should take place in stages. This allows all relevant parties to review how the first stage was implemented, and it allows for adjustments to systems in readiness for the extra volume numbers associated with the further reduced threshold.

All this suggests that a lower threshold cannot be introduced very early in the first term of the Abbott Government, even though the prevailing political wisdom is that distasteful reforms need to be introduced very early in the term of a new government.

Further, the desirable staged reduction in the threshold to its ultimate long-term level may push implementation of this reform agenda into a new federal parliamentary term, which raises the prospect that part of the reform would have to run the gauntlet of an election.

Jean Baptiste Colbert once said: “The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least amount of hissing.” The low value import threshold issue is likely to be the Abbott Government’s first real test on “public” tax reform. It is hoped that substantial consumer hissing will not divert it from sound decision-making.

Dale Boccabella is an associate professor of taxation law at the Australian School of Business. Boccabella, and colleague, Kathrin Bain, will present a paper on the GST low value import threshold issue at the January conference of the Australasian Tax Teachers Association in Brisbane, 20-22 January 2014. A version of this post appeared on The Conversation.

Professor James Morley

During the global financial crisis and its aftermath, inflation remained stable in most advanced economies, including Australia. This stability should have come as somewhat of a surprise. And understanding what is behind this surprise can inform us about what to expect for inflation in the coming year.

Australia has an inflation target of 2-3% and the Reserve Bank of Australia (RBA) has been very successful in achieving this target over the past 20 years. So why, then, do I think the recent stable inflation in this range has been a surprise? The simple answer is that, even given an inflation target, it would be hard for Australia to resist large external inflationary or deflationary pressures for very long. And there are many reasons to have expected such pressures from the global economy over the past few years.

The quantitative easing of many central banks following the financial crisis, especially the dramatic measures by the US Federal Reserve, led many economists to predict a return of the high levels of global inflation from the 1970s. Yet, this high inflation has failed to materialise.

One reason often given by other economists for the failed predictions of high inflation is ongoing weakness in the European and US economies, with unemployment rates still well above their pre-crisis levels. Yet high unemployment leads to another puzzle, which is why global inflation hasn’t declined from the 2-3% range or even become negative as most economic models that link the unemployment rate and inflation would have predicted.

The best answer economists can give for the stability of inflation despite the topsy-turvy times for the global economy is that inflation-targeting policies in many economies have anchored the public’s expectations of inflation in the 2-3% range. These expectations become self-fulfilling as wages and prices are set based on them.

As a concrete example of the public’s stable inflation expectations, one can look at the implied “break-even” inflation expectation for Australia based on the difference between the interest rates on nominal and real government bonds. This measure of expected inflation has hovered around 2% for a number of years and remains at this level as we start the new year.

So what do I expect for inflation in Australia in 2014? Like the bond market, I think inflation will remain at the low end of the 2-3% range. Headline measures may go temporarily higher as we see the one-time effects of the recent fall in the Australian dollar on petrol prices and other import goods. But underlying inflation should remain subdued, especially given a weak labour market.

The RBA has signalled that it would be comfortable with an even lower Australian dollar and improvements in the US economic outlook will likely deliver just that. Any such depreciation of the dollar will mechanically increase some prices, especially the cost of overseas travel.

But according to many empirical studies, the “pass-through” of exchange rate movements to most retail prices in countries like Australia and Canada has greatly diminished in the inflation-targeting era. So even a further 10-15% depreciation of the dollar should not have much effect on ongoing inflation.

It might seem like a boring New Year’s prediction … but inflation will remain the “dog that didn’t bark” in 2014.

James Morley is a professor of economics at the Australian School of Business. This post previously appeared on The Conversation.

Richard Holden

Qantas should remain our national carrier – but not a nationalised one. The Australian government can throw the struggling airline a lifeline, but it must not stifle competition by giving Qantas an unfair advantage over rivals such as Virgin. Instead, I suggest the government invest in Qantas and take on debt that, because of the Qantas Sale Act, the airline can’t borrow from elsewhere.

Qantas is not just a private sector business facing stiff competition and cost pressures. Yes, it’s iconic, but it’s much more than that. Qantas opens up Australia to the world and the world to Australia. In short, Qantas is not some beleaguered car manufacturer that happens to employ quite a lot of people. It’s a crucial part of our national infrastructure. In the language of economics it provides “positive externalities”: to the tourism industry, specifically, and Australian individuals and businesses more generally.

Can other airlines such as Virgin play this role? Actually, no. Virgin Australia has just five intercontinental planes, compared with around 50 at Qantas; it’s domestic network is one-third the size of the Qantas network. And as impressive as it is, Virgin’s brand will never resonate as “Australian” in the same way overseas. For tourism, this is especially important. And when it comes to connecting a large, far-flung continent with itself and the world, size matters.

In the wake of Qantas’s projected half-year loss of $300 million and recent debt downgrade there has been much discussion about what, if anything, the federal government should do to assist. Everything from re-nationalisation to leaving Qantas to its own fate has been canvassed.

Although competition has been difficult for Qantas, it has also helped the national carrier. Competition has forced Qantas to be more innovative and efficient. A good plan to help Qantas should not shield it from the market. Re-nationalisation would do just that. Even a partial government stake would be problematic, forcing the Commonwealth to wear two hats: one as owner and one as government.

The government must apply some market rigour to its decision. If you rescue Qantas from competition, why didn’t we rescue Ansett a decade ago? Simply because nationalised airlines don’t work: they grow inefficient pretty quickly, and that was why Qantas was privatised in the first place. Under public ownership it was flying to places that the government thought it should fly to – such as Rome, Paris and Zurich. However these routes made no sense commercially. At least Qantas as a public company is a nimble operator that can take decisions based purely on a commercial imperative.

What then, can the government do?

In my view, the government should buy subordinated but low-yielding long-term debt in Qantas. Because of the Commonwealth’s low borrowing costs, this could be revenue neutral to the taxpayer while lowering Qantas’s cost of capital significantly and freeing up its balance sheet. It would also remove the pressure of possible debt downgrades such as that from Standard and Poor’s recently.

This is a real problem – S&P’s revision of Qantas’s rating from BBB- to BB+ (outlook negative), which is below the lowest investment grade. Such a withering downgrade  makes it much more expensive to raise debt on the markets as it effectively recommends stock in the airline should not be actively considered. The airline could face a $100 million rise in its annual interest bill, higher leasing and hedging fees and the loss of some investors unable to invest in companies rated “junk”. Equally, the transfer of revenue from credit card companies will be delayed.

However, if the government steps in and is willing to buy long-term debt in Qantas, such debt could have a term of 25 years, thus giving Qantas more certainty and ability to weather short-term fluctuations from fuel price shocks, downturns in the economy, and the like.

Should Virgin get the same deal, as CEO John Borghetti has said? No. In part because of its smaller network, Virgin has a naturally lower cost base and is not encumbered by the ownership restrictions contained in the Qantas Sale Act, so it already has access to cheaper capital. Virgin’s recently announced $350 million capital raising, underwritten by Air New Zealand, Singapore Airlines and Etihad, is clear evidence of that.

Borghetti has also said he’d be happy to see the Qantas Sale Act abolished allowing Qantas and Virgin to compete on a “level playing field”. But let’s be realistic: the Qantas Sale Act is not going to be abolished any time soon. That is a political certainty, and it’s a constraint on how Qantas can be helped.

Qantas is as much a part of our national infrastructure as it is our national DNA. It’s not just another private company. It’s different, it’s special, and it needs help. But let’s not be sentimental about it.

I strongly urge the government to take action in a smart way that preserves airline competition. Don’t nationalise Qantas, but buying long-term bonds in the airline would guarantee it capital it can’t get elsewhere.

Richard Holden is a Professor of Economics at the Australian School of Business. A version of this post appeared in The Australian.

Professor Fred Hilmer

Earlier this year I was invited, along with Rod Sims, head of the Australian Competition and Consumer Commission, to address the new Mexican government on competition policy. This was not unusual – it followed similar requests from other countries hoping to lift productivity through competition reform, including the Canadian, Indian, Japanese and New Zealand governments, as well as the Organisation for Economic Co-operation and Development (OECD).

In one way this is ironic, given Australia’s own productivity growth has stalled since 2003. What the continued international interest tells us is that the competition framework that emerged from our review into national competition policy (NCP) in the 1990s has stood the test of time. It is in the area of implementation that we have dropped the ball.

Prime Minister Tony Abbott’s announcement last week of a new review of competition laws and policy is welcome and, if anything, overdue. Australia’s economy and the international economic climate have changed. Moreover, in recent years we have been failing to apply some of the basic tenets of the NCP reforms, and the cost of that failure is all too evident.

It is worth remembering that Australia’s economy prior to the NCP was one of the world’s most heavily regulated. Many key infrastructure industries including power, gas, transport and telecommunications were restructured, and well over 1000 anti-competitive regulations were reformed.

The Productivity Commission concluded those reforms lifted Australia’s gross domestic product (GDP) by at least 2.5% over levels that would otherwise have prevailed. Our GDP growth – after years of sluggish performance – was one of the highest in the OECD between 1993 and 2005, underpinned by strong productivity growth.

Now, the need to lift productivity is back on the agenda: our rate of annual improvement in multi-factor productivity has dropped to below 0.5%.

Our most serious failure has been in the area of regulation review. A very significant factor behind the boost to GDP was the dismantling of anti-competitive regulations. As long as the National Competition Council drove the process, using the carrots and sticks of annual competition payments to the US, it was taken seriously by all governments.

About 1800 pieces of legislation were reviewed: reforms included dismantling legislated cartels in agricultural marketing and deregulating domestic aviation, utilities, retail trading and liquor licensing.

In 2007, with the National Competition Council out of the picture, the Council of Australian Governments broadened the scope of regulation review, shifting the emphasis to principles of so-called best practice. But it is attempting, in one process, to cover three areas – anti-competitive regulation, ineffective regulation and red tape generally – when very different skills are needed for each.

A competition review focuses on the impact of regulation, barriers to entry, pricing and incentives, and requires a sound understanding of how businesses operate and compete, micro-economic literacy and legal training. To assess regulation effectiveness requires a background in policy analysis. To deal with red tape, expertise in process mapping and work-flow analysis is critical.

This confusion about what is required has, in my view, led to worst practice. It’s not just our processes that are the problem – too often we’re not observing process at all. All new regulations are intended to pass an impact assessment review against the best-practice principles.

Yet individual or cabinet ministers can decide to bypass this, in which case a post-implementation review (PIR) is required to ensure the negative effect of regulations made in haste can be remedied.

It had originally been anticipated that there would be few exceptions. However, as the Productivity Commission noted in 2011, the number of exceptions had risen to 60 in the four years since the regime was introduced, with one-half occurring in just the last 12 months.

Examples of bypassed reviews include the industrial relations changes of 2010, the minerals resource rent tax and, closer to my current role, the legislation establishing the Tertiary Education Quality and Standards Agency (TEQSA).

The fact that the fail-safe mechanism, the PIR, is needed in key areas indicates that the requirement for ex ante regulation review via regulation impact statements is being avoided and ignored.

There is no point in having a competition framework if the regulatory process allows barriers to competition without proper review and scrutiny.

Not all our reforms worked, and there are lessons to be learned. We did not put enough emphasis on public versus private ownership, believing that if the industry structure was right, public ownership could co-exist with competition.

For example, in NSW where all three electricity generators were owned by government, we expected they would compete in a similar way to private enterprise. This clearly was not the case. Competitive markets require at least a significant number of privately owned firms – public interest should be promoted through regulation rather than government ownership.

The second lesson is the need to define more clearly the boundary between private property rights and public interest.

The regime that governs access to essential facilities such as the rail tracks and airports is being reviewed by the Productivity Commission but the issue remains problematic.

Obviously, 20 years on, there are new challenges and opportunities. Important areas that should now become the focus of competition policy include health and education, where there is limited use of competition but the design of markets is flawed. For example, in healthcare, competition too often becomes a zero-sum game of cost shifting rather than competition for the most effective treatment. In higher education, volume (enrolments) is deregulated but price (student fees) is tightly controlled.

In both of these areas, there is increasing interest in the role of competition policy in spurring innovation as well as driving down costs.

Another focus of the review should be high-growth, high-tech industries, which raises the vexed question of the national broadband network. I seriously doubt that having the cutting edge of online innovation subject to anti-competitive regulation will lead to the best outcomes.

It may not be easy to unscramble the regime that’s been created but we need to try. Only a robust competitive environment will deliver the opportunities made possible by these technologies.

It is difficult to estimate just how much this latest review might yield in terms of GDP growth and productivity. In the 1990s we were coming off a very low base, so the gains were considerable. Our current productivity performance is so bad that we should be able to hope for comparable economic gain. Certainly we should approach the review with high aspirations.

But political will for reform must be strong, as it was in the 1990s. The dire warnings of those sectors that had been shielded from competition via regulation fortunately did not win the day then, and should not be allowed to dictate national policy now.

Professor Fred Hilmer is Vice-Chancellor of the University of NSW. He chaired the independent committee of inquiry into national competition policy in the mid-1990s. This article has appeared in The Australian Financial Review.

Professor John Piggott

The past month has seen a small whirlwind of publications and data releases on demographic change. There was the Productivity Commission’s well-researched paper, An Ageing Australia; new data and projections from the Australian Bureau of Statistics indicating longer lifespans (again); a paper from the National Seniors Productive Ageing Centre on the financial benefits of delaying retirement; and a paper from the Grattan Institute calling for further pension age increases.

They support the idea that we are living longer – one of humanity’s triumphs. But it brings with it the need to adjust institutions and policy to accommodate a changing demographic structure.

Demography gets much less attention from economists than it ought. Population ageing dynamics generate changed government outlays and economic growth patterns. Take the idea of a demographic dividend – a period when low fertility and still evolving late-life longevity mean that the working age population makes up an unusually large proportion of the total. A buoyant labour market and limited calls on government outlays to support education and retirement transfers mean governments sometimes reduce taxes and neglect pension access age.

Then there’s a flip point, and within a few decades the picture is entirely reversed. Social support structures require more government expenditures and the labour tax base shrinks relative to GDP. Japan’s demographic dividend flipped in the mid-90s and that country has been economically challenged ever since. We’re now experiencing Australia’s flip point – the population share of those aged 15 to 64 peaked in 2009.

At the same time, life expectancy at mature ages is increasing. Whereas most of the life expectancy increase in the three decades following World War II was generated by declines in mortality at young ages, during the past 30 years the increase in life expectancy has come from reduced mortality at later ages, generated by medical and pharmaceutical breakthroughs, and also behavioural changes such as reduced smoking.

Official estimates indicate Australian male life expectancy at 65 increased by more than 2.5 years just between 1998 and 2009 – from 16 to nearly 19 years. Healthy life expectancy seems to be going up, too. Other calculation methods can lead to significantly higher estimates.

This trend to a longer life and an older population will continue. What can policymakers do?

Well, plan. This will be an inexorable change for Australia, as elsewhere, but it will take a while. We can start to change policy now.

People are already working longer than they were (though not as long as they did 40 years ago). One of the most important levers to encourage older people to remain in the workforce is to increase pension access age. The superannuation access age need not be the same, but it shouldn’t be far off.

At the moment, there is a five-year gap between tax-free superannuation payout and age pension age. It would be good not to increase that gap. The increase in age pension age to 67 by 2023 is what The Netherlands has done. It also added an automatic link between access age and life expectancy to take effect in the future. This helps to distance politics from the access age adjustment.

More imaginative retirement products, and the market and regulatory structures to support them, would help – a topic for the Murray inquiry into financial services. Policies aimed at delivering more aged care in the home and community will also be important, not just because that’s what people want, but also because it is less expensive.

And then there’s the revenue requirement. Tax as a proportion of GDP will have to increase to maintain the age pension and health services at their current levels. But baby boomers’ greater demands and expectations will mean services are likely to cost more, even on a per-user basis. The aged-care policy framework is a good example, as was recognised in the Productivity Commission’s latest costing.

Tax policy needs to take this into account. For my money, some increase in consumption taxes seems inevitable. It is less distortionary than most other taxes, it reaches the retired as well as workers and is therefore robust to changing ratios of retirees to workers, and the poorest in the community are largely protected because they tend to rely on government transfers which are indexed.

Whatever mix is chosen, planning can start now. The government’s proposed white paper on taxation would be a good place to start. Australia is ageing but still relatively young, with some sustainable age-related structures already in place. We need to keep that up.

John Piggott is a Scientia Professor of Economics and director of the ARC Centre of Excellence in Population Ageing Research at the Australian School of Business.

Helen Hodgson

The latest consultation paper released by Treasury on the governance of superannuation funds doesn’t include any surprises. There are no policy recommendations of the type the Grattan Institute called for in its recent report; instead, it focuses on compliance and transparency issues and builds on work done in previous reviews.

However, it does need to be examined through the lens of the Coalition Government’s commitment to reduce regulatory red tape, as articulated by Assistant Treasurer Arthur Sinodinos in his first major speech in the role.

A number of reviews during the term of the previous Labor government identified shortcomings in relation to the regulation of the superannuation system. Notably, the Cooper Review led to the MySuper reforms, which were intended to demystify and promote better engagement with the superannuation system for members by offering a standardised product without bells and whistles.

This was followed by a Productivity Commission report on the role of default superannuation funds, and the Fair Work Commission was given the task of reviewing the default superannuation funds nominated in modern awards taking account of the new MySuper products.

Treasury’s consultation paper seeks input on three aspects of the regulation of superannuation funds. (Its closing date is February 12, 2014.) First, it addresses the governance of a fund and the composition of its trustees, questioning the need to have an equal number of employer and employee representatives, instead promoting the idea of independent trustees.

It would be easy to regard this as a “union busting” measure, overriding a requirement that has been incorporated in the Superannuation Industry (Supervision) Act 1993 since the legislation was enacted. However, the landscape of the superannuation industry has changed significantly during the past 20 years.

The basic rule of 50/50 representation applies to employer-sponsored funds, which have decreased in number from 1,405 in June 2004 to 122 in June 2012, and now only control 4% of assets in the superannuation sector.

Other funds, including most industry funds, are required to have an arrangement in place that is approved by the members of the fund and APRA (Regulation 4.08A Superannuation Industry (Supervision) Regulations 1994); a requirement often met through establishing a policy committee with employer and member representation, frequently through a relevant union.

The number of industry funds has also declined during the past eight years, though the number of member accounts has increased. The composition of the board of trustees or policy committee should enhance transparency: whether this is best achieved through the involvement of employee representatives or through independent trustees is a moot point.

Many in the university sector will have been affected by changes made to Unisuper which have had an adverse impact on entitlements, though the relevant clause was approved by both the consultative committee, which has 50% employee representation, and the board, which has employee and independent representation.

The second issue raised by Treasury relates to transparency and the way in which funds report their performance. MySuper will adopt a form of simplified “dashboard reporting”, though the consultation paper suggests that this may be deferred beyond the proposed start date of July 1, 2014, and the paper asks whether a similar form of simplified reporting should be more widely adopted.

There are a number of threshold questions that need to be considered as part of this proposal, including determining which benchmarks are the most useful to superannuation fund members and how those benchmarks should be defined.

The third issue addressed in the paper seeks to explore the implementation of the Productivity Commission’s recommendations regarding default superannuation funds in modern awards. Although the Fair Work Commission has commenced a review of default funds, with the intention of developing a list of default superannuation funds, the consultation paper notes that this goes further than the Productivity Commission recommendations.

It seeks guidance on how default funds should be nominated: whether any MySuper product should be acceptable or whether a high quality list should be developed, and who should be responsible for that process. This aspect is again attributed to a desire to cut red tape, though it could also be attributed to an ideological view of the award process.

Overall, the issues raised in the consultation paper are matters that need to be reviewed in the context of the present superannuation environment. The balance of regulation and compliance costs is difficult to get right: unnecessary regulation can increase costs to employers and to members as funds comply with the requirements.

However, in a mandatory superannuation system there must be sufficient regulation to protect members’ entitlements, and members must be empowered to understand how their retirement funds are being managed. Reductions in red tape should not be allowed to override the need to look after the members of these funds.

Helen Hodgson is a senior lecturer in the School of Tax and Business Law at the Australian School of Business. A version of this post appeared on The Conversation.

Ronald Masulis

Reputation concerns create strong incentives for independent directors to be viewed externally as capable monitors as well as to retain their most valuable directorships.

In our paper, Reputation Incentives of Independent Directors: Impacts on Board Monitoring and Adverse Corporate Actions, co-author Shawn Mobbs and I extend this literature significantly by examining the effects of differential reputation incentives across firms that arise when a director holds multiple directorships.

Firms having boards composed of a greater portion of independent directors for whom this directorship represents one of their most prestigious are associated with firm actions known to reward directors and are negatively associated with firm actions known to be costly to director reputations.

Specifically, they are associated with a lower likelihood of covenant violations, earnings management, earnings restatements, shareholder class-action suits and dividend reductions. In addition, we also find they are positively associated with stock repurchases and dividend increases.

We also find evidence that these directors are motivated to retain these valuable directorships and thus, they have incentives to not upset a CEO who can exert substantial influence over their renominations to the board.

Firms with boards composed of a greater portion of directors for whom this is one of their most prestigious directorships are associated with CEOs having a greater fraction of equity-based pay as well as higher total pay, which is in part compensation for their higher risk-bearing.

We also report in an earlier study, forthcoming in the Journal of Financial Economics, that the sensitivity of CEO forced turnover to performance is higher for these same firms, which is another source of higher CEO risk-bearing that also necessitates higher CEO pay.

One concern with the greater use of option-based pay and an incentive to build a cordial relationship with the CEO is a greater willingness of the board to allow backdating of option grants to increase CEO compensation in a non-transparent manner.

However, we find that boards with a greater proportion of independent director with greater reputation incentives are less likely to experience “lucky” CEO option grants. This suggests the incentives to please the CEO do not dominate the incentives to be viewed as a careful monitor by the labour market.

Finally, there is evidence that these boards also are more negatively disposed to takeovers and more positively disposed toward CEO empire-building, which both protects and increases the relative prestige of their directorship, raising the reputation benefits of being a director.

Using alternative approaches to extract out firm size effects potentially embedded in our director reputation measures, including a matched sample based on firm size and controlling for the expected size factor in our director reputation measure by using randomising director-board assignments, reduces concerns that firm size is the primary driver of our findings. The results are consistent with directors being more concerned with their reputation at their largest directorships.

In summary, these findings underscore the importance of considering individual reputation concerns. Although directors have an incentive to retain their more prestigious directorships and expand these firms’ empires, the main findings in this study indicate that director reputational concerns dominate directorship retention concerns.

In conclusion, the findings of this study document that reputation-based incentives are important for researchers, firms, and policy-makers to understand.

The full paper is available for download here.

Ronald Masulis is a Scientia Professor of Finance and Macquarie Group Chair of Financial Services at The Australian School of Business. H. Shawn Mobbs is an Assistant Professor of Finance Economics, Finance and Legal Studies at the Culverhouse College of Commerce. A version of this post appeared on the Harvard Law School Forum on Corporate Governance and Financial Regulation.