This piece published today at The Monthly online.
Image by Vernon Chan (Flickr).
Despite being haunted by the spectre of WorkChoices, the campaign by the Coalition in support of business interests and against labour remains systematic and thorough.
Head over to The Monthly to read the full piece.
Originally published at The Guardian.
‘It’s Hockey’s promised constant federal budget surpluses that are unsustainable, not budget deficits. Photograph: Mike Bowers/Mike Bowers
Joe Hockey, the treasurer, now concedes he may not be able to deliver his promised budget surplus any time in the foreseeable future. This news is good for private savings because, when the government runs a surplus, the non-government sector must run a deficit.
This is a simple reality of macro-economic accounting. There are only so many Australian dollars. If the government taxes more than it spends (a surplus), it is taking more dollars out of the private sector than it is putting in. Assuming exports equal imports those dollars can come from only one place – private domestic savings. Everyone’s surplus is somebody else’s deficit.
Why almost nobody understands this or reports on it is something of a mystery. It’s an economic and accounting reality that has been talked about for many years by monetary economists such as Professor Bill Mitchell and his colleagues at the University of Newcastle.
The arithmetic is very simple. Total net financial assets in Australian dollars is the sum of government assets, plus net private domestic assets (individuals and businesses), plus net foreign assets. If the federal government runs a surplus then the money has to come from one of the other two. Given the government has virtually no control over the foreign component, a surplus will usually be accompanied by a reduction in savings in the domestic private sector (households and businesses) as they pay more in tax than the government is spending into the private economy.
When the federal government runs a surplus, private debt almost always increases. In other words, the banks create the money to fill the hole left by the government surplus. The much heralded surpluses of the Howard/Costello government were precisely matched by non-government deficits. These budget surpluses were partly supported by trade surpluses (foreign sector deficits) but even so, private debt increased dramatically.
Because there is a finite net number of Australian dollars in the private sector at any one time, total surpluses and deficits across all sectors of the economy must, by definition, sum to zero. The data, of course, support this conclusion. Data from Australian Bureau of Statistics via the University of Adelaide’s Steven Hail.
Hockey has stated that he wants to reach budget surplus and then remain there. The only way that this is sustainable is if we match the budget surplus with a trade surplus – if we export more than we import. Trade balances are largely beyond the government’s control, certainly in the short term. This means that the sustainability and stability of a budget surplus is also beyond the government’s control – as Hockey is belatedly coming to realise.
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In the absence of a strong trade surplus, a government surplus can only be achieved by reducing private sector savings – either directly reducing actual savings or being funded by new debt. This is simply an accounting identity, it’s true by definition. There is nowhere else for the money to come from. Similarly, in order for the private sector to increase savings relative to the trade balance, the government must run a deficit. Again, there is nowhere else for that money to come from.
The implications of this simple accounting reality are profound indeed. Our entire national conversation about government finances is based on false premises. When Hockey says he wants a budget surplus, what he’s also saying is he wants to reduce private sector savings. Is that a good thing or a bad thing? At a time when private sector debt is heading up towards 200% of GDP, I’d be inclined to think decreasing private savings is a bad thing. Private sector debt is a much, much bigger potential problem in this country than public sector debt.
It’s Hockey’s promised constant federal budget surpluses that are unsustainable, not budget deficits. You cannot continually pull more money out of the private sector than you’re putting in without destroying the economy.
When the truth is the opposite of what we’re being told, it’s a good idea to examine who benefits. Privatising the deficit means big gains for lenders. Lending money to the public is far more profitable than owning government bonds. The financial sector are both the greatest beneficiaries of such policies and among the greatest donors to both the Coalition and Labor. Coincidence? Maybe.
I reviewed the below FactCheck for the conversation. Unfortunately there is little space as a reviewer to say much but I would like to have gone into more detail discussing who really loses and who benefits from changes in company tax rates.
I’ve advocated in the past for a reduction in company tax rates but only as part of reforms that increase taxes on speculation and rent-seeking. I don’t think the overall tax burden should be reduced but I do think we could target it better so that we encourage productive economic activity that doesn’t damage the environment while discouraging speculation and other rent-seeking.
It is true that our “headline” (or statutory) corporate tax rate of 30% is higher than that of many other countries. (AAP Image/Dean Lewins)
By Kevin Davis, Australian Centre for Financial Studies
“Well, Jon, the Government’s about to bring in a 1.5% corporate, or company, tax cut from the 1st of July. That’s something that obviously we support, because (the) corporate tax rate at 30% is not competitive with the rest of the region and we need to drive that down.” – Innes Willox, Australian Industry Group Chief Executive, ABC Melbourne Radio with Jon Faine, February 3, 2015.
Mr Willox’s comment followed Prime Minister Tony Abbott’s National Press Club speech on February 2, where he promised “a small business company tax cut on July 1 – at least as big as the 1.5% already flagged.”
It is true that Australia’s “headline” (or statutory) corporate tax rate of 30% is higher than that of many other countries, particularly some like Hong Kong, Singapore and Ireland, which have used low tax rates to help attract international investment.
When asked by The Conversation for data to support Mr Willox’s statement, a spokesman for the Australian Industry Group referred to the Henry Tax Review, which found that:
“Relative to other similar size OECD countries, Australia’s company income tax rate is high.”
As the table below shows, Australia’s rate is above typical Asian and European rates in 2014, but not markedly out of line with the G7 countries (Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States).
[The original article contains a figure comparing headline company tax rates but I could not reproduce it here for some reason.]
But, Australia’s dividend imputation tax system means that any comparison of our current 30% rate with statutory corporate tax rates elsewhere is like comparing apples and oranges.
Much of Australian company tax paid is rebated to shareholders, via the distribution of franked dividends and the attached tax credits are used by Australian shareholders to offset their income tax. The more tax paid by the company, the less to be paid by the investor.
Imputation tax systems are rare internationally, with Australia and New Zealand the main examples. In contrast, there is generally “double taxation” of dividends (full investor-level taxation of dividends paid out of after-tax company income) in classical tax systems common overseas, although some involve a lower personal tax rate on dividends versus wage income.
To illustrate the difference, let’s say we had $100 of Australian company income. Australian company tax is paid at 30% and the remaining $70 is paid to an Australian shareholder with tax imputations attached to them. For argument’s sake, let’s say that shareholder is also on a 30% income tax rate. That $70 of dividend income they just received would not be taxed again. The total government tax take is $30. For the same situation under a classical tax system, the investor would be levied a further $21 of income tax (30% of the shareholder’s $70 dividend), giving a total government tax take of $51.
So, in the case where the Australian company has only Australian shareholders to whom it distributes all after-tax income as franked dividends, the company tax is “washed out” via the tax credits distributed to the shareholders.
Reducing the company tax rate would simply mean the company in the example above distributes more cash but fewer franking credits to attach to the dividend. Less tax would be paid by Australian companies and more by Australian shareholders in the form of income tax.
If company tax rates were lowered, foreign companies would pay less tax and the shortfall in the government tax take would not be made up by income tax (because foreign firms cannot distribute franked dividends to shareholders).
Overall government tax revenue may decline because of less company tax paid by foreign companies and also where Australian companies retain earnings rather than paying them all out with franking credits attached.
Franking credits are of no value to foreign investors who would benefit if the company tax rate were lower. So foreign investors do look closely at how Australia’s corporate tax rate compares with other countries.
But foreign investors also consider non-tax issues, including government budgetary outcomes, when deciding where to invest.
It is true the corporate tax rate at 30% is higher than some other countries in our region, but it is average compared to G7 countries. Further, Australia’s franked dividends system means Australian shareholders already enjoy favourable tax conditions on income earned from their investment in companies. However, foreign investors do not benefit from franked dividends and would benefit from a lower company tax rate in Australia.
I agree with all of what has been said above but would add that Mr Willox’s statement conceals some value judgements.
As Kevin Davis has shown above, it is true our headline corporate tax rate of 30% is higher than that of our neighbours in the region. But given our system of dividend imputation, it is questionable at best to say that having a headline corporate tax rate higher than our neighbours makes us uncompetitive. Economic and political stability are big factors for businesses making investment decisions, as is available infrastructure, wage rates, other taxes, and the nature of the industry in question.
To Kevin’s analysis, I would also add that there is potential for a “race to the bottom”, where international competition drives company tax rates ever lower, resulting in ever dwindling government services for the population. – Warwick Smith
This article was originally published on The Conversation.
Read the original article.
There are no laws in economics. Free market and small government ideology are trojan horses for plutocracy.
The below op-ed was published in last week’s Australian. It is critical of my piece in The Guardian the week before. I contemplated publishing a reply but after reading the piece properly there’s actually very little substance to reply to. I know it’s an opinion piece and there’s not a lot of space to mount a proper argument but it’s very puzzling to me that a professor of finance would bother to write such an empty piece and that The Australian would publish it (OK, perhaps not entirely surprising as ideology is a pretty obvious explanation for both events). Anyway, here is the piece in quote marks with my response interspersed. If you want to read the uninterrupted piece from The Aus then follow the link below.
Federal finances and family budgets have a great deal in common
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 denied 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.
I think this last paragraph is something of a straw-man as it doesn’t accurately represent the content of the articles in question. In my case, what I argued was that inflation should be used as the constraint for government spending instead of taxes and borrowing and that comparisons with households are irrelevant. This is different from arguing that restraint by the Coalition is ideological (I think it is but that is actually a separate matter). As best I can tell all Australian politicians make use of these false analogies.
I suspect the need to begin this piece with a straw-man reveals the entire story behind this op-ed: the author has no argument to make but simply doesn’t like the conclusion reached by the economists (including myself) he cites and misrepresents.
There is a very important insight contained in the above exchange between Professor Swan and I. Economic policy is fundamentally about the translation of values. This is not science, it’s philosophy. Your economic policy is going to depend on the kind of society you want. The economic policy – indeed the very economic system – follows on from decisions about values.
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?
Yes they have. There are no “laws of economics”. Economics is not a natural science like physics. Our economic system is a construct and nowhere is this more obvious that in monetary economics. To think that there are somehow laws of economics is to have fallen victim to the greatest con of our age. We constructed the economic system and we can reconstruct it if it’s not working for us.
Smith, a research economist, 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.
So, first the logical fallacy of the straw-man is used. Next the logical fallacy of guilt by association. Zimbabwe is the economics equivalent of Hitler and the Nazis – you know the drill, mention somebody or some policy and Hitler in the same sentence and you make them look bad by association. “Does Peter not realise that Hitler was elected and therefore democracy is a flawed political system?”
Professor Swan is making exactly this kind of empty attack by invoking Zimbabwe in a discussion of money creation. What he fails to mention is that first Mugabe destroyed Zimbabwe’s productive capacity and then tried to print the country’s way out of economic trouble. Last I noticed Australia still had productive capacity and the point of my article was that you can create money when there is spare productive capacity i.e. in conditions precisely the opposite of those that existed in Zimbabwe. I don’t know if Professor Swan understands this but chose not to say it because it undermined his argument or if he doesn’t understand it. Neither paints a very flattering picture of his op-ed.
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.
Is it only me who finds this pretty amusing? What Professor Swan is effectively saying here is that individuals and households are exactly the same as the federal government except in a few critical ways that make them completely different. He also fails to mention one other fundamentally important difference which is that individuals and companies in Australia are required to pay tax in Australian dollars.
The consequences of these differences between households and the federal government are profound. Again, it’s wild that Professor Swan would glibly state this fundamental difference between households and government as if it’s inconsequential. It’s true that I can create my own currency but I cannot force anybody to use it nor force anybody to pay me using it. The federal government can do these things and the flow on consequences are as fundamental to our financial system as energy is to our real economy.
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.
Professor Swan now makes a huge and unjustified leap to start discussing the negative consequences of inflation. There are two possibilities here: he either didn’t read my article or he’s deliberately distorting it in order to make his argument. The whole focus of my piece was on using inflation as the guide and limit to government expenditure. If inflation is the primary focus then why would he expect there to be high inflation? The only way inflation would be a problem under a system which specifically focusses on inflation is incompetence. The idea is to use both monetary and fiscal policy working together using economic capacity and inflation as their guiding measures.
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.
This is simply false. Virtually all Australian government debt is denominated in Australian dollars. In Professor Swan’s defence, prior to the 1980’s what he said was true. Perhaps he needs to update his figures.
Printing money simply devalues the Australian dollar, magnifying both the interest and the principal repayment burden.
Even for an op-ed this is mind-boggling in its lack of nuance. How much has the creation of trillions of dollars in the US during quantitative easing devalued the US dollar? How much inflation has it caused? What’s the interest and principal repayment impact? I’ll give you a clue – virtually no impact on any of these things at all. Yes, printing money when there is no spare capacity in the economy has negative consequences. Hint – don’t do it then, do it when there’s the capacity to absorb it. It’s not that hard.
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.
As I’ve argued elsewhere, the whole government debt burdening future generations thing is just another myth. Future generations standard of living will not be burdened or restricted by our debt. Their standard of living will be restricted by the goods and services they produce. As Warren Mosler says, you can’t send goods and services back in time to pay for past expenditure. You only have to think outside the household analogy to realise that what Professor Swan says here is illogical. Only if people like him hold sway on governments will today’s debt impact on future generation’s standard of living because they will impose mindless austerity policies on future generations in order to achieve their aims of privatising and financialising our entire lives.
There is a cost of governments overspending today and that cost is inflation today. This is why inflation is the best constraint on government expenditure. It seems this point entirely escaped Professor Swan. As Upton Sinclair said “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” Similarly it is difficult to get somebody to understand something if it undermines their entire career’s work. Professor Swan’s resistance is understandable in this context. However, as physicist Max Planck put it “[a] new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it.” These are not scientific truths that we are discussing but they are the realities of modern finance as we have constructed it.
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.
Finally we get to the substance of this article. Professor Swan is a small government, free-market advocate. At the very extreme end of this spectrum are those who think the role of government should be restricted to law enforcement, national security and the enforcement of property rights. It’s code for handing all the power in society over to the rich. There is no equal opportunity in a laissez-faire economy. If you’re born wealthy you will very likely succeed and if you’re not you won’t. It seems that’s the Australia that Professor Swan wants. Unfortunately for him he’s completely out of step with the overwhelming majority of Australians who see the government’s role as much greater than that.
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 in the school of banking and finance, UNSW Business School.
This last paragraph is like the Zimbabwe fallacy but an even worse attempt at guilt by association. It demonstrates once again that Professor Swan is trapped in a pre 1970s framework. The post Bretton Woods financial world is radically different from that under Bretton Woods between WWII and 1971. That Professor Swan would use Greece as a warning for Australia shows us that he doesn’t understand the post Bretton Woods era. Because Greece does not have the capacity to create its own currency it is out of options. The Euro cannot save Greece. If Greece still had its own currency it would have a raft of options for escaping its current problems including money creation for economic stimulus. There is plenty of spare capacity in the Greek economy to absorb money creation without causing inflation – no Professor Swan, Greece is not comparable to Zimbabwe.
It’s taken a lot of words to show it but the op-ed in The Australian contained no coherent argument against my Guardian article or the others cited by Professor Swan. Ultimately he reveals his motivation in the third last paragraph where he advocates for a system that hands virtually all power in society to the wealthy. In other words, Professor Swan advocates for a plutocracy in the guise of a small government, free market economy. That’s not what I want and, happily, it’s not what the overwhelming majority of Australians want. It’s important that we watch out for trojan horses like those that Professor Swan and the editors of The Australian offer us.
Warwick Smith
This is an expanded version of an article originally published at The Guardian.
By Warwick Smith
Published by the Transnational Insitute.
Abstract
Many corporations donate to both sides of politics. One of the reasons they do this is to ensure both major parties in an election have sympathetic policies. When both major parties share a policy stance it is effectively removed from democratic scrutiny. The focus of political campaigns and media interest is on areas of policy conflict, the rest is passed over in silence. Corporations often purchase political silence in order to avoid scrutiny of unpopular activities, such as junk food advertising targetting children or the exploitation of gambling addiction.
Corporations don’t give their money away for nothing. There is an understanding (rarely made explicit) that large campaign donations buy political access and favourable consideration in policy development and legislation. Why else would a corporation, which is bound by law to pursue profits, make these donations? Interestingly, many businesses give money to both sides of the narrow political divide; sometimes different amounts, sometimes exactly the same amount. In the lead up to the 2013 federal election in Australia, for example, Inghams gave the opposing Labor and Liberal parties each $250,000, Westfield gave them each $150,000 and ANZ gave them each $80,000. By my count, over one third of donors (excluding individuals) gave to both the coalition and Labor during 2012/13. This is not unique to Australia but occurs in all democracies. For example, in the Unites States, a Center for Responsive Politics analysis found that 48 out of the 100 biggest non-individual donors to gubernatorial election campaigns donate to both sides.
Donating equally to both sides is clearly not about helping one side win. It’s an implied threat: “if you don’t treat us well we’ll give you less and they’ll be ahead.” When both major parties have the same policy on an issue, it effectively removes that issue from democratic scrutiny. This is the aim of many political donations from businesses who stand to lose from policy changes that would be popular with the electorate. Only areas of difference between contenders end up being discussion points during elections, the rest is passed over in silence.
Such a big deal is made out of the few policy differences between major parties that during campaigns they can appear to be poles apart. However, the main contenders in most developed democracies are actually very closely aligned with respect to political ideology and policy – particularly economic policy.
Silencing debate
During their last term in office, the minority federal Labor government in Australia were more or less forced by independent MP Andrew Wilkie to attempt to implement restrictions on poker (slot) machine gambling. Prior to the discussion of reforms beginning, gaming industry lobby groups were giving similar amounts of money to both major parties but slightly favouring Labor. As soon as Labor started talking seriously about reform, the donations began to dramatically favour the opposition Liberals. The leader of the Liberal party, Tony Abbott, came out strongly against the reforms and they were eventually abandoned.
During the period in question, surveys showed that a large majority (70-75%) of Australian voters supported poker machine reform to limit the impact on problem gamblers and their families. The voters lost that one as they often do when wealthy industries are lined up against them.
The gambling interests won the game and showed the Labor party that they weren’t bluffing. The gaming industry has effectively paid to have the issue taken off the national political agenda. The view of the voting public is no longer relevant. There are many more examples of this process where corporate and other wealthy entities punish reformists by shifting financial support. The best-documented examples in recent Australian political history are the mining and carbon taxes and the Future of Financial Advice (FoFA) reforms. There has been plenty of coverage of these issues so I won’t repeat the stories here.
Once a policy issue is effectively silenced, ongoing donations to both major parties help to entrench major party dominance. Large donations to both the Liberal and Labor parties further marginalise minor parties who may seek to break the silence on policy issues that the corporates or elites have purchased. In Australia, the Greens are strong advocates of poker machine reform so donations that advantage the major parties over the Greens are still worth making for corporates who want this issue out of the spotlight. When it’s a two horse race, the outcome is relatively easy to control.
A consequence of this donation-driven approach to politics is that many areas of open political debate between and within major parties are in policy areas that the wealthy elite don’t care much about, like same sex marriage or abortion, or represent divisions between corporate interests. Of course, some vestiges of ideological differences remain and show up in areas such as industrial relations and welfare.
Ideology and history
Industrial relations is a good policy area for revealing the complexities that I’ve so far ignored. In the same way that I have just argued that corporate donations purchase policy and legislative consideration, you could argue that union donations to the Labor party purchase industrial relations policy. However, this would be a gross simplification as the labour movement and the Labor party are intimately entwined in much more than just a monetary sense and industrial relations policy has been at their core from the beginning.
Of course, business interests have also been at the heart of the Liberal party for its entire existence. Have they been corrupted by business interests or was that their platform from the beginning? We can track some of this movement over time and see which parties have shifted and in which direction.
Shift in Political Compass scores for major UK political parties from 1972-2008
The political divide between left and right has historically been much greater across the English speaking democracies than it is today. There was a time when the parties of the left were drawn from and represented the working class and the parties of the right were drawn from and represented business. Then businesses started courting the parties of the left and drawing them right. An economic consensus, neoliberalism, emerged during the 70s and 80s that enlisted politicians of all stripes. The Thatcher, Reagan and Hawke/Keating (Australia) governments prosecuted this agenda in their respective countries, irreversibly changing the political economy of the English speaking world. Neoliberalism is essentially pro-business at the cost of democratic control and social cohesion and once it was the consensus position of all major parties, its march was beyond the capacity of democracy to halt. As has been noted by others, neoliberalism is nothing new, it’s simply capitalism expressed in the absence of effective labour opposition.
These changes followed the oil shocks of the early-mid 1970s and were the result of extremely effective political opportunism on the part of business lobby groups. The high inflation and low economic growth experienced as a result of the quadrupling of oil prices was just the opportunity the industry groups (particularly the financial industry) needed to push for radical reform. The Nixon administration’s abandonment of the gold standard in 1971 had opened up the potential for entire new fields of financial business, the repercussions of which are still being felt today. The extraordinary growth of the financial industry in the intervening four decades began with the collapse of the Bretton Woods agreement in 1971 but was really given strength by the economic reforms of the 1980s and 90s that occurred across the developed world.
Beyond the cash
It’s clear that policy formation and the legislative agenda of major political parties is not explained simply by following money trails. However, the money trails are our best portholes into the rest of the opaque process. Who attends fundraising dinners with senior politicians that cost $10,000 a plate? What do they talk about? It’s easier to spin a story to voters about why you watered down regulations than it is to tell the bankers whom you mix with socially and professionally why you couldn’t help them out. Personal relationships matter to politicians as much as to the rest of us.
Sitting in the middle of this process are the lobbyists and think tanks who invent public rationalisations for policy positions that serve their clients’ interests.
“Among all the things I’m going to tell you today about being a journalist, all you have to remember is two words: governments lie.”
US journalist I.F. Stone to journalism students
Lies are most effective when the liar believes them. The first step in effective lying is to convince ourselves of the lie. This is where the think tanks and lobbyists come in, telling politicians, for instance, that financial regulations have to be eased because compliance is onerous and damaging to the efficiency of business. Too much red tape chokes economic activity. I’m sure many in the current Coalition government in Australia really believed this reason for watering down financial advice regulations but I guarantee the idea originally came from the banks or their lobbyists who simply want to continue to offer advice that is in their own financial interests, rather than those of the customer.
This is a complex and dirty game dominated by political donations, vested interests, personal ambition, class and power. Voters are a part of the game but representing their interests may not be a politician’s top priority. Politicians will only act on behalf of voters if no wealthy or powerful group objects – or if the party in question is boxed into a corner by a hung parliament or a combination of marginal electorates and strong community action.
Everywhere that democratic power has existed it has been under siege from wealthy interests. If the people are to recapture and maintain control of their democracies then they must insist on transparency in political financing and be resigned to never ending vigilance and protest. The extent to which corporate interests have removed issues from democratic scrutiny needs to be more broadly understood and communicated. A democracy taken for granted rapidly becomes a plutocracy.
Author Bio
Warwick Smith is an economist, ecologist, philosopher, businessman and writer. He has very broad professional interests including the application of evidence in public policy formulation, political philosophy, taxation economics, environmental economics, and the history and philosophy of economics.
Warwick blogs at reconstructingeconomics.com, and tweets @RecoEco.
This morning I was on 2ser‘s breakfast program with Mitch Byatt discussing the proposal in my recent Conversation article that we should be increasing taxes on economic rent (unearned income). As usual with such a subject much of the interview was taken up with explaining what economic rent is. It would be good to change the name but the horse has bolted. I like the term unearned income, I think that captures it pretty well.
You can listen to the six minute podcast of the interview here.
Thanks Mitch and 2ser.
By Warwick Smith
Originally published at The Guardian.
Our political and economic thinking has been warped by bad analogies to the point where we can’t see the real economy. The Abbott government is happy to play along.
‘National governments with their own currency bear absolutely no resemblance to a household or a business.’ Photograph: Scott Lewis/flickr
Friday 9 January 2015 10.57 AEST
To prosecute its economic agenda, the Abbott government has relied on the constant repetition of economic myths. I’ve previously dealt with the myths of the budget emergency, the debt crisis and the endlessly repeated lie that the carbon tax was wrecking the economy – but these are only the most obvious myths and not necessarily the most important.
This week, Mathias Cormann repeated one of the other great myths of modern government financing, saying that it was “unfair to rob our children and grandchildren of their opportunities [in order] to pay for today’s lifestyle”.
The suggestion that future generations will have a reduced standard of living because of our government debt needs some unpacking.
What is it that limits the standard of living of people in 2030? It’s the goods and services that those people can produce. As Warren Mosler is fond of saying “goods and services cannot be sent back in time in order to pay for past spending.” The standard of living of people in 2030 will be a factor of the number of workers and their productivity, not how much debt their government carries from the past. So where does government debt fit in?
As I’ve explained elsewhere, the finances of a sovereign government with its own fiat currency bear absolutely no resemblance to the finances of a household or a business. The federal government can create money. They don’t create all of the money that they need for all their expenses because that would cause out-of-control inflation.
The obvious conclusion to be drawn from these two uncontroversial facts is that taxation and borrowing are not the limiting factors on government expenditure, inflation is. Acknowledging this completely turns the mainstream commentary on government financing on its head.
The federal government does not need anybody else’s money in the form of taxation or borrowing in order to spend. They can create money. The reason they tax and borrow is to take money out of the economy so that their spending does not cause inflation or affect official interest rates. In other words, taxation and government debt are tools for economic management, not for revenue raising.
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You may have to sit with all this for a moment and calm the voice in your head that is telling you it can’t possibly be true. Our political and economic thinking has been so thoroughly colonised by the finance industry that we often find it difficult to see the real economy. The real economy is the labour of workers combined with capital and land to produce goods and services.
How did the massive postwar government debts impact on the lives of people living in the 1950s and 60s? It didn’t. These are often referred to as the “golden years” where inequality fell and the standard of living rose at a dramatic pace. Could the workers in the postwar years send their goods and services back in time to support or pay for the war effort? Of course not, it’s a ludicrous proposition. Abbott and Hockey’s suggestion that future generations will suffer because of today’s government spending is just as ludicrous.
The only way in the real economy that future generations can suffer because of today’s government debt is if the government raises taxes or cuts spending in order to repay the debt and this causes higher unemployment. This is never necessary and governments who advocate this (like the Abbott government) have fallen prey to household finance analogies.
While there is spare capacity in the economy, inflation risk is low and there is room for greater government expenditure. One simplistic measure of spare capacity is unemployment. While there is excess unemployment there is room for more (targeted) government expenditure. In other words, sovereign governments have the capacity to always maintain low levels of unemployment if they use inflation as their expenditure cap rather than taxes and borrowing.
If unemployment is the only price future generations pay for today’s government debt and the government can always lower unemployment by more spending, what’s the impact on future generations of government debt? None. Why then don’t we just go on a massive spending spree and have huge debts? Because spending beyond the productive capacity of the real economy would cause inflation.
The costs of too much government expenditure are felt immediately afterwards in the form of inflation and are not borne by future generations.
Hopefully now you can see the full picture. Government expenditure today is not limited by taxation or borrowing but by inflation risk. Government expenditure in 2030 will not be limited by taxation, borrowing or previous debt but by inflation risk. When you’re first presented with these facts it can seem like a magic pudding or a perpetual motion machine but that’s just because we’re used to thinking about finances from a household or business perspective.
National governments with their own currency bear absolutely no resemblance to a household or a business. All of the frequently used analogies give a distorted picture of the reality of government finances. To get a clear picture you need to peel back all the layers of finance speak and look at the real economy.
There are many important conversations and debates we should be having about government finances, the role of government, productivity, consumption and leisure. We cannot have them while the government and media commentators perpetuate myths about how our economy actually functions. Ultimately the material standard of living of future generations is going to depend on the productivity of workers and on a safe environment and climate. Now there’s a policy conversation worth having.
On 12 January 2015, this article was amended to attribute a quote to Warren Mosler.
By Warwick Smith, University of Melbourne
The first incarnation of the now-gone mining tax focused on economic rent. Is targeting powerful rent seekers too hard? AAP/Kim Christian
Tax is back in the spotlight with coalition MPs and the Australia Institute talking about getting rid of some of the exemptions to the GST. There has also been a lot of talk about whether or not corporate Australia is paying their fair share of tax. Many big companies, including Apple and Google have been in the firing line because of the small amount of tax they pay on their Australian earnings. Some suggest that our corporate tax rate is too high and this creates a strong incentive for multinationals to shift taxable income to other countries.
Lowering our corporate tax rate and shifting to taxes that target economic rent could help resolve structural problems with our tax system, create a more productive economy and reduce incentives for corporate tax dodging. Such a tax shift could be designed to be revenue neutral or to increase overall tax take.
Even for many economists, economic rent is a slippery term that’s difficult to grasp. Economic rent is unearned income. This means that it has no clearly associated cost of production.
Unearned income can be obtained in many different ways but is almost always derived from privileged access to something scarce. The market power that monopolies can employ to raise prices generates economic rent. A rise in land values beyond inflation generates economic rent for the owner (the “earned” income from real estate is the actual rent or value derived from the use of the land). Unearned income also comes from artificial scarcity created by government policy. Taxi licenses and poker machine licenses are clear examples.
When a communication company uses a part of the electromagnetic spectrum for profit making, nobody else can use that wavelength. The auctioning of electromagnetic spectrum is an effective type of economic rent tax. The spectrum gets put to efficient use and the public is compensated for giving up a shared resource. The company then profits according to how well they use the resource rather than simply because they have a monopoly over it. There is bipartisan support for the auctioning of electromagnetic spectrum but the principle can be applied much more broadly.
The same logic sits behind mineral resource rent taxes – such as the first incarnation of the now-abolished mining tax. When the international price of a resource goes up, those who own the resource (every Australian) receive little benefit. The benefit goes to the mining companies even though they have done nothing to facilitate those price rises and they don’t own the material whose price has risen. This is unearned income and could be taxed in order to return the income flows to the public.
Most businesses in Australia would greatly benefit from a tax shift to economic rents with a commensurate reduction in company tax and the abolition of inefficient taxes such as stamp duties and insurance taxes.
Vast sums of money that are currently directed towards rent seeking would be redirected into productive activity, generating employment and diversifying the economy. Boom and bust property cycles would be flattened due to reduced speculation and, as a result, the broader scale ups and downs of the business cycle would be somewhat moderated.
While the 2010 Henry Tax Review recommended many rent-based taxes (including land tax, gambling taxes and a resource rent tax) as well as taxing environmental degradation, very few of the recommendations were endorsed, let alone implemented. The most significant of the recommendations that were implemented (even if somewhat half-heartedly), the carbon tax and the mining tax, have recently been repealed, primarily due to the inevitable backlash of the rent-seekers.
The political hurdles to serious tax reform are very high. However, the consequences of not reforming the tax system are severe. Tax reform policies are easy prey for opportunistic political opponents. This is why we need some clear principles for tax reform that are clearly explained to the public.
Liberal politicians should favour shifting taxes off productive business and onto economic rents and the exploitation of shared resources because such reforms target market failure and free up productive and sustainable businesses to flourish. Labor politicians too should approve of these principles because they reduce taxes on labour and shift them onto the rent seekers who contribute little to society. The inherently progressive nature of most rent taxes should also appeal to The Greens, the Labor left and the increasing number of others concerned about economic inequality.
Our politicians will need courage to stand up to powerful individuals and groups who have an interest in maintaining the status quo. They can get that courage from the rest of us who stand to benefit from a taxation system that supports a more productive and sustainable economy.
This article was originally published on The Conversation.
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It has recently been pointed out to me that some of my writing on monetary economics has not given proper attribution to the intellectual tradition behind the ideas that I present and that this gives the impression that these are my ideas. I’m embarrassed to admit that the criticisms are spot on and I have made a major misjudgement in how I wrote these articles (one in The Conversation and one in The Guardian). I apologise unreservedly to those who may have felt aggrieved by my actions.
I have a history in public policy activism and I have approached my recent popular political and economic writing somewhat from an activist standpoint where I viewed the main game as advocating and causing public policy change and increasing public awareness. The branch of monetary economics known as modern monetary theory (MMT) has something of an activist element to it where a minority who hold an accurate view of how things are and, perhaps to a lesser extent, how things should be, are vying for airtime against the overwhelming majority who hold (or at least communicate) a false perspective on monetary economics and public finance.
I thought that I could add a new voice and a new strategy to that struggle by simply writing about monetary economics from an MMT perspective but as if it’s just the uncontroversial (among economists) truth about monetary economics rather than a minority view among economists. I think the complexities of intra-discipline disagreement are impenetrable for newcomers and will put most people off investing the effort to understand the arguments.
Taking this line of thinking led me to make a serious misjudgement in what I wrote and how I wrote it because MMT is more an intellectual and academic discipline than it is an activist movement and, as such, people’s careers and their professional profiles are at stake. Again, I apologise to the people whose work has inspired some of my writing who have not been properly acknowledged including Warren Mosler, Perry Mehrling, Bill Mitchell and Steven Hail.
I wrote to the Guardian editors requesting a couple of additions. They agreed to add attribution to a line early in the article that credits Warren Mosler but not to make further edits post-publication. I’m a strong believer in owning up to mistakes and trying to remedy them when others are affected.
I believe MMT faces serious challenges in part because of its name and the way it is usually presented. A better name would be something like Fiat Currency Economics because MMT is not a theory but is primarily just a description of reality and the clear consequences that flow from that reality. No economist that I’ve found has any clear and well reasoned refutation of MMT to offer. All attempts at refutation appear to rely on misunderstandings or misrepresentations. This is why I took the approach of not referring to MMT at all in the pieces that I wrote. Nevertheless, I still should have referred to the people whose work contributed to or provided the ideas for the articles and I greatly regret that I did not. I promise I will not make this mistake again.
Below is a list in rough descending order of significance with respect to influencing my views on monetary economics.
Perry Mehrling’s Coursera course The Economics of Money and Banking
Warren Mosler’s book The Seven Deadly Frauds of Economic Policy
Various presentation given by Steven Hail
University of Newcastle’s CofFEE report on the Job Guarantee
Professor Bill Mitchell’s blog – this is the most comprehensive of the sources here but it’s low on my list because I came to it quite late in the formative period of my thinking on money and finance.
This government is fond of comparing the economy to a household budget – but there is one really major difference. AAP/Lukas Koch
By Warwick Smith, University of Melbourne
Treasurer Joe Hockey is experiencing difficult times. Deteriorating terms of trade and an uncooperative senate mean that he cannot deliver the surplus when he said he would and he cannot continue to cut government expenditure without risking a recession.
I have some comforting news for Joe Hockey: the importance of the whole deficit/surplus thing has been greatly exaggerated – with a lot of help from Joe himself of course. The focus on deficits and surpluses distracts us from what’s really important in the macro economy.
Hockey and Abbott are very fond of using household analogies when discussing government finances – Hockey again compared Australia’s economy to a household budget in his Mid-Year Economic and Fiscal Outlook. However, a government that is sovereign with respect to its own fiat currency bears no resemblance at all to a household. Such a government creates the money we all use, either physically on a printing press or, more importantly, electronically in the accounts of financial institutions.
Everyone understands that governments can create money. Most people also understand that governments don’t just create all the money they need for all the things people want because it would cause inflation. Inflation is the devaluation of money. If you have a really good season for growing apples and there is a glut, the price of apples falls. Similarly, if you have a glut of money, the price of money falls. That’s inflation.
So, here lies the key insight. Inflation is the limiting factor for government expenditure, not taxes or borrowing. A government that can create money doesn’t need your money from taxation or from borrowing in order to spend. There is no limit to how much money a sovereign government can spend, but if government spending plus private spending exceeds the productive capacity of the economy then you get inflation.
The real calculation faced by government should not be about how much money the government has – it has an infinite amount. The calculation should be about the capacity of the economy to absorb government spending without driving inflation.
Seeking a balanced budget and automatically borrowing any deficit spending (as we currently do) is an effective but unsophisticated way of ensuring government spending doesn’t cause runaway inflation. Taxes and government borrowing remove money from the private sector, creating space for government spending (which injects money into the private sector). Remember, the government does not have to borrow or tax in order to finance spending because they can create money.
The slowing Australian economy combined with the dramatic fall in global oil prices mean that inflation is set to fall and unemployment is rising. This is precisely the kind of environment into which the federal government could spend without borrowing (i.e. create money). Times like these represent opportunities for the government to finance productivity improving infrastructure and provide much needed services for nothing. I know it sounds too good to be true but this is the reality of a fiscally sovereign government.
Can the government just spend as much as it wants on whatever it wants? Of course not, the result would be out-of-control inflation. Can it spend a lot more than it currently is without substantial negative consequences? Absolutely.
The much discussed “quantitative easing” in the US, UK and EU is an example of this kind of spending (though very poorly targeted). The US Federal Reserve has created trillions of dollars out of thin air and used it to buy risky financial assets and government bonds in order to take the risk off the balance sheets of financial institutions and improve their supply of money. The money was created with keystrokes on a computer which simply credit the accounts that these financial institutions hold with the Federal Reserve. There has been no runaway inflationary impact of this “printing” of trillions of dollars.
This reality of fiat currency is very difficult for many people to grasp but it’s not quite the magic pudding that perhaps it appears to be. When a government creates money, it isn’t creating value from nothing. The value lies in the human and capital resources that are underutilised in the economy. The money created by the government is simply the lubricant needed to mobilise these resources.
So, productive government spending is limited by the capacity of the economy to provide the goods and services that the government wants to purchase plus the goods and services the non-government sector wants to purchase. During economic downturns, and especially in recessions, there is spare capacity in the economy which can be employed by government. It’s possible, with this in mind, to quite easily return to the post-war days of genuine full employment even during an economic downturn.
Until people understand the basic realities of monetary economics we cannot have a meaningful discussion of government finances. Rather than worrying about deficits and surpluses we should be asking whether the economy would benefit from greater or lesser government expenditure or taxation. This calculation balances unemployment, spare capacity, and the need for infrastructure and services against inflation risk. It’s a complex calculation but the underlying principles are pretty straightforward.
Let me just restate for emphasis: the need for balanced federal budgets is a myth. Like many myths, it does have some factual historical origins. Back when currencies were backed by gold it was possible for governments to go broke. Because modern currencies are not backed by anything material, sovereign governments cannot run out of money and can never be insolvent in their own currency. Somehow, mainstream political thinking hasn’t kept up with the dramatic changes in the monetary system that occurred more than 40 years ago.
The first of our politicians to really understand this and to communicate it effectively to the public will have at their disposal the tools to completely reshape our economy for the better. I know politicians can be slow off the mark but 40 years is long enough. It’s time they caught up.
This article was originally published on The Conversation.
Read the original article.
Reconstructing Economics 