What tax and spending reforms might be feasible in Australia?

The government’s recent tax discussion paper contemplates a similar tax reform agenda to that recommended by the Henry tax review in 2010. The general thrust of the proposals is a move away from taxes which hamper efficient allocation of resources (e.g. stamp duties on property transfers) and taxes which impose disincentives on investment (taxes on capital income) or productive effort (high taxes on labour income).

Some commentators, for example Peter Martin in the SMH, have suggested that the discussion paper “has set out the case for an increase in Australia's rate of goods and services tax”.  Perhaps the report hints in that direction, but the Treasury research findings noted in the report do not seem consistent with the view that there are large gains to be had from substituting increases in GST for the taxes that have highest economic costs. The marginal excess burden (MEB) on GST is estimated to be in the medium range (around 20%) along with taxes on labour income, compared with an MEB of around 50% for company tax. As discussed in my recent post on the intergenerational report, the MEB of a tax rises exponentially with increases in the rate of the tax. If the relevant elasticities are such that the MEB on GST is currently around 20% (rather than around 10% as I previously thought) a doubling of the rate would cause the MEB on GST to 50% - as shown below.

It seems that the only way to get large economic gains by substituting one tax for another would be by relying more heavily on land taxes (and municipal rates) which, according to Treasury research, have a slightly negative MEB. The use of land tax to replace stamp duties on property transfers would make a great deal of sense from an economic perspective and should not pose huge political feasibility problems. People who cannot afford up-front payment of the land tax (e.g. old people who often income-poor despite being asset-rich) could be given the option of having payment deferred until after death, with appropriate interest being charged.

However, I find it difficult to imagine that increased revenue from land taxes could do much more than to replace some of the most highly distorting taxes used by state governments. Perhaps I could fire up my imagination by reading what Henry George had to say many years ago about the desirability of funding government by a single tax on land. However, I doubt whether any politician could persuade the electorate to accept substantial losses on the wealth invested in their homes in the hope that they might enjoy the benefits of lower taxes on capital income. Most Australian politicians are not even game to contemplate the merits of subjecting home owners to the same capital gains tax regime as is applied to owners of other assets.

One way in which it might be feasible to obtain benefits from lower taxes on capital income would be to reduce the tax concessions applying to superannuation. It might also be possible to reduce government spending by tightening up the assets means test on aged pensions. The potential for a bi-partisan agreement emerging in these policy directions has recently emerged with the Labor party offering to end superannuation concessions for the wealthy and the Australian Council of Social Services (ACOSS) suggesting that the assets test on aged pension eligibility should be tightened to better target the pension to those who need it.

At first sight these indications of a willingness among some politicians to contemplate a reduction of concessions to the elderly might appear to be attempting to swim against the tide of grey power – the growing proportion of old voters in the electorate. Paradoxically, however, the ability of any group to benefit from redistributions extracted from the rest of the community tends to diminish as it comes to represent a higher proportion of the population.

A big question which groups representing old people need to face is whether they stand to gain more by using their political muscle to increase their share of the economic cake or by using their political muscle to increase the size of the economic cake. As the elderly come to represent a higher proportion of the population, their attempts to obtain a larger slice are eventually likely to reduce the size of the cake by leading to higher tax rates and thus dampening economic incentives. A larger slice of a smaller cake could end up to be very little indeed. The elderly can possibly defer the time of reckoning by encouraging governments to adopt a complacent attitude toward growing government debt, but that strategy runs the risk of great hardship if the welfare system becomes unsustainable and has to be sacrificed to repay debt. 

Perhaps we are now beginning to see the political limits of grey power in Australia. The way ACOSS is using its influence seems likely to produce outcomes along the lines of those I predicted a few years ago when I considered the question of whether the elderly poor tend to fare better under a pensions means test than under universal pension benefits:

“As the increase in proportion of elderly people in the population in Australia reduces the per voter political power of this group, I would expect the per voter political power of the elderly poor to diminish to a smaller extent than that of the much larger group who hope to benefit from the private superannuation tax and pension means test rorts. I expect incentives for early retirement implicit in the superannuation arrangements will be an early casualty as attempts are made to contain government spending on retirees. If a choice has to be made at some time in the future between, say, maintaining the current level of the aged pension in real terms and maintaining superannuation tax concessions, I expect that maintaining the aged pension levels would be likely to win the political debate. Similarly, given a decline in grey power on a per voter basis I doubt whether superannuation tax concession would win the political debate if a choice has to be made at some time in the future between maintaining these tax concessions and an overall lowering in income tax rates to promote economic growth.”

After reading that again, I hope that the government doesn’t forget to obtain a substantial reduction in tax on capital incomes as a quid pro quo for a reduction in superannuation tax concessions.

The conclusion of my last post that young people have good reason to be concerned about their futures is also relevant in considering what tax and spending reforms might be feasible. As young people become more aware of the range of factors that affect their future well-being, more of them can be expected to show interest in the way economic policies are impacting on their own incentives to acquire skills, and on the incentive for investors to take the risks that will need to be taken to ensure the growth of remunerative employment opportunities. Perhaps young people will come to recognize that, as a group, their interests are likely to be best served by lower government spending and lower tax rates.

When a government throws all the pieces of tax and spending policy in the air there is no guarantee that what we will end up with will look any better than the mess we had before. On this occasion, however, there are some grounds for optimism. The political winds seem to be blowing in the right direction .

Postscript
I have just noticed that Treasury estimates of marginal excess burden of GST in their working paper, Understanding the Economy-wide Efficiency and Incidence of Major Australian Taxes (2015–01) imply a much smaller increase at higher tax rates than shown above. See Chart 20, page 36. The Treasury estimates are more likely to be correct, but it would be nice to be able to understand the reasons for the difference.

Should young Australians be more concerned about their futures?

Young Australians do not seem to be particularly concerned about their futures. The data discussed in a recent post suggests that measures of optimism and pessimism depend a great deal on the specific question that is asked and the context in which it is asked. Nevertheless, it is reasonably clear that young Australians are less pessimistic than young people in many other high-income countries.

Perhaps young Australians should be more concerned about their futures. In considering this question I will rely largely on two reports: 

• Renewing Australia’sPromise: Will young Australians be better off than their parents? (authorship anonymous) published by the Foundation for Young Australians (FYA) in November 2014; and
• The Wealth of Generations, by John Daley and Danielle Wood, published by the Grattan Institute in December 2014.

The FYA report attempts to compare the lives of young people today and their future prospects with the lives and prospects of their parents when they were at a similar age. Young people are defined in various ways e.g. between 15-24 years of age, 20-24 and 25-34. The comparisons are largely between relevant data for the present and thirty years ago (1985). The aspects covered by the comparisons are: work and incomes, education, housing, government services, health and environment.

The focus of the Grattan report is somewhat narrower than that of the FYA report. It looks in some depth at change in household wealth, incomes, and government taxes and transfers of people in different age groups.

The environment: 

The FYA report argues that Australia is likely to become a hotter place and to be more at risk of fire and drought as today’s young grow older. Some precautionary measures are desirable even if the FYA report is too pessimistic. From an international relations perspective it is important for Australia’s efforts to control GHG emissions to be defensible in international forums. (Interestingly, the FYA report does not include a discussion of international relations; perhaps the region in which we live is now so peaceful that the potential for international conflict no longer comes readily to mind as an important factor affecting the wellbeing of future generations of Australians.)

If the climate change pessimists are correct, nothing Australian governments can do will make much difference, except for policies supporting adaptation. Technological advances will probably help future generations to cope with any increased risk of fire and drought if appropriate investments are made in research.

Health: 

The FYA report suggests that young people will live longer and healthier lives than their parents as a result of advances in medical technology and adoption of healthier lifestyles. Between 1985 and 2015 life expectancy of 25 year olds increased by 6.2 years for males (from 74.5 to 84.7) and by 4.5 years for females (from 80.3 to 84.8).

Education: 

Over the last 30 years there has been a massive increase in the amount of time people spend being educated but the quality of education does not seem to have kept pace with that in other OECD countries.  Data presented by FYA shows Year 12 completion rates have risen from 44% to 77% (20-24 age group) and the percentage of people with university degrees has risen from 26% to 35% (25-34 age group). PISA scores indicate that basic skills in maths and reading have slipped substantially relative to the OECD average.

Housing: 

The Grattan report notes that home ownership is declining, especially among the young. The percentage of 25-34 year olds owning their own home slipped from more than 60% in 1981 to 48% in 2011. FYA notes that the ratio of house price to income rose from 3.2 in 1985 to 6.5 in 2015, while the ratio of housing loan interest to income rose from 3.9 to 7.1. However, the Reserve Bank’s estimates suggest that repayments on new housing loans as a percentage of household disposable income were much the same in recent years as in the mid 1980s.  The relevant percentages are higher than in the early 1980s, but lower than in the late 1980s.

It is also relevant to consider how the price of housing and rents compare with movements in the CPI over the past 30 years. Over the period from December 1984 to December 2014 the CPI All Groups index rose on average by 3.6% per annum, the housing component of the index rose by 4.1% per annum. Over this period, the annual rate of increase in the rental sub-group was 4.9% in Sydney, 4.0% in Melbourne and 3.3% in Hobart. This data is not consistent with a general decline in affordability of rental accommodation over the last 30 years.  The fact that it is costing more to live in Sydney suggests that many people find Sydney to be an attractive place to live.

Government Services and Taxation: 

The FYA report makes the widely-known point that over the next 40 years an increase in the proportion of old people in the population is likely to result in an increase in government spending on programs which benefit older people, while young people are likely to be required to contribute more in taxation and to receive less services in return. Young people are already contributing more than their parents’ generation; this is evident in the increase in average student (HECS) debt on graduation from zero in 1985 to about $24,000 in 2011.

The Grattan report provides a more detailed examination of intergenerational transfers. It notes that since 2003-04 there has been a substantial increase in net transfers per household of $9,400 to the 65+ group - mainly in the form of health spending and cash benefits - which has been funded by increases in government debt.

The Government’s latest intergenerational report has projected that under current legislation net debt per person will rise from $10,400 in 2014-15 to $65,000 mid-century, measured in today’s dollars. It is probably not reasonable to expect old people, children and others on relatively low incomes to make much contribution to servicing that debt, so a middle income earner could be looking at having to service an additional debt approaching $100,000 on top of their home mortgage.

We can expect the open season for crazy tax ideas to continue in Australia until we manage to get government spending under control.

This cartoon by Nicholson was published in “The Australian” newspaper in 2010.

Work, incomes and wealth: 

Data presented in the FYA report indicate that the unemployment rate of 13% for 15-24 year olds is similar to that in 1985. However, there are many young people engaged in casual and part-time employment who would prefer to work more. Over the past three decades the percentage of young people who are not able to get as much work as they would like has more than trebled (rising from 4.7% to 16.6%). 

As to the future, a decline in the proportion of young people in the population will not necessarily bring about a return to the situation where young people will be able to find secure employment more readily. Technological change can be expected to continue to result in displacement of a growing number of occupations and labour market regulation may continue to favour people who have secure employment relative to job-seekers. Technological change will also provide new opportunities, but the FYA report makes the important point that ability to take advantage of such opportunities will depend on skill development to ensure that “technology augments young workers rather than displacing them”. That might be easier said than done in the context of current opposition to labour market deregulation and education reform.

The FYA report notes that there has been a modest increase of 6.8% in median weekly earnings of 15-24 year olds over the last 30 years. That represents a rate of increase five times slower than experienced by people aged 45-54.

The Grattan report shows that older Australians have also captured most of the growth in Australia’s wealth over the past decade. Households in the 65-74 age bracket are on average $200,000 wealthier than households of that age eight years ago, while the wealth of households in the 25-34 age bracket have gone backwards. The main driver of the growth in wealth of older Australians has been an increase in house prices. Young people have missed out on this as a result of their lower home ownership rates.

As an old person it would be easy for me to be complacent about growing intergenerational disparities of wealth. After all, it is reasonable to expect that older people will ultimately pass on much of their accumulated wealth, isn’t it? Data in the Grattan report suggests, however, that inheritances are typically received later in life and primarily benefit people who are already wealthy. Gifts to younger generations are typically small and also primarily of benefit to well-off households.

Concluding comments

In the past I have often tried to dismiss the fears that young people have expressed to me about their future lives with some comforting words about the benefits of ongoing economic growth. I still think the problems discussed above will be manageable if Australia can maintain rates of economic growth comparable to those experienced during the last 30 years. 

   

However, it will be difficult to maintain economic growth comparable to the past, given projected changes in the age structure of the population. We may not have much economic growth at all if an increasing tax burden is placed on investors and medium to high income earners. Investors can easily find attractive opportunities elsewhere in the world and medium to high income earners are likely to be increasingly attracted by the pleasures of early retirement, particularly if they can look forward to a government-funded pension after their savings are sufficiently depleted.

In my view young Australians have good reasons to be concerned about their futures.

Does the McClure report provide a basis for sensible welfare reform?

My first impression of the report of the Reference Group on Welfare Reform was not favourable. I couldn’t make sense of it.

The four pillars metaphor got in the way of the story the report was attempting to tell. When I went looking for the structure that the pillars were meant to support I got lost. So I then went looking for four major problems that reforms were intended to address and could only find two.

At that point I realized that the pillars were just a device to tell readers that the material in this report has been organised under four subject headings.  The reason why the material was organized in this way still escapes me, but that probably doesn’t matter. The report was probably not intended to be read by people like me.

One of the major problems that the members of the reference group (Patrick McClure, Sally Sinclair and Wesley Aird) have sought to deal with is the complexity of the existing system of welfare payments. The report is concerned that complexity creates problems for individuals in understanding the system and accessing support, and makes it more difficult to administer the system efficiently. There is also an underlying problem of inequity, with people in similar circumstances being treated differently. The reference group has proposed a simplified payment architecture, with five primary types of payment. It looks like a sensible reform, but I am not well placed to comment.

The other major problem that the reference group has sought to address is long-term dependence on income support by people who have potential to become self-reliant. The report proposes that the problem be tackled with an investment approach along the lines of that adopted in New Zealand. The key features of the proposed approach seem to be:

• Conducting actuarial calculations annually to estimate the lifetime liability (i.e. contingent liability to government) of the overall income support system and support for specific groups.
• Identifying those groups at greatest risk of long term income support dependence and those groups with the strongest chance of breaking this reliance with tailored support.
• Making a broad range of services available to assist at-risk clients to break their reliance on income support. The Federal Government is envisaged to be the driving force behind service delivery.
• Ensuring that interventions are evidence-based, and “testing and learning” to ensure continuous improvement of support services.

The proposed investment approach seems promising, but it is not obvious that the report has taken into account criticisms of the New Zealand scheme, such as those raised by Simon Chapple in an article published in 2013. Chapple pointed out that the investment approach adopted in New Zealand can produce policy outcomes that are inconsistent with a standard cost benefit framework. For example, the investment approach counts movement of people off welfare for any reason – including movement into the black or grey economy, emigrating and going to prison - as a benefit.  It provides the administering agency with an incentive to focus on reducing government spending rather than achieving more desirable outcomes such as helping welfare beneficiaries gain employment.

In my view Chapple’s objections to the New Zealand scheme should probably not weigh heavily against the adoption of a similar scheme in Australia, but the issue deserves more careful consideration than I can give it here. It would have been desirable for the reference group to have discussed the issues involved in its report. It will be interesting to see how Patrick McClure or other members of the group now deal with the similar criticisms that have been raised against their proposals by Michael Fletcher. They can hardly argue that their report speaks for itself.

If this report had been prepared by the Productivity Commission I am sure it would have provided a more thorough investigation of the fundamental issues that should be considered before the government adopts an investment approach to welfare along New Zealand lines.

Have Australians become highly pessimistic about prospects for future generations?

On “Personal Reflections” last week Jim Belshaw mentioned a conversation with one of his daughters who said she and most of her generation had given up on the idea of home ownership because it was no longer an achievable dream. I would not be surprised if many young Australians hold such views these days.

Jim mentioned his conversation in the lead-in to his discussion of the results of some polling by Essential Research, which asked respondents whether they think that over the next 40 years various groups of people will be better off or worse off than they are today. The results are surprisingly negative. Apparently, only 14% think that retirees will be better off. The corresponding numbers for other groups are: 15% for the middle aged; 14% for families with school aged children; 18% for young adults and 24% for children.

I suspect that respondents may have been primed to be somewhat pessimistic in their responses by preceding questions which Essential asked in the survey. Those questions were about awareness of the Intergenerational Report, consequences of the changing population age structure and climate change.

The results of a poll conducted by Essential after last year’s budget are similarly pessimistic. The poll suggests that 21% of Australians think that the standard of living for the next generation will be better than today, 27% think it will be much the same and 48% think it will be worse (4% don’t know).

An Ipsos Mori survey, reported in The Guardian in April last year, asked a range of questions and seems to have obtained somewhat more optimistic responses. When all respondents were asked do “you feel that your generation will have had a better or worse life than your parents' generation”, 40% said better. Responses to that question by people under 30 were less optimistic: 30% said better. When all respondents were asked “do you feel that today's youth will have had a better or worse life than their parents' generation”, 30% said better. Again, responses by people under 30 were more pessimistic: only 22% considered that today’s youth would have a better life than their parents.

The Ipsos Mori (I.M.) survey suggests that Australians are more optimistic than people in most high income countries, although they are much less optimistic than people in China and some other countries experiencing rapid economic growth. A similar picture emerges from surveys by Pew Global which asked: “When children today in (survey country) grow up, do you think they will be better off or worse off financially than their parents?”. The Pew data is available for a larger number of countries and for both 2013 and 2014. Unfortunately data for Australia (and some other countries) was only collected for 2013.

The results of the I.M. and Pew surveys can be compared from data shown in the graph below. In constructing the indexes shown in the graph I assigned a value of 1 to “better”, -1 to “worse” and 0 to “same” and “don’t know” (and averaged the I.M. data when two years data was available).

In order to put some perspective on this data it would be desirable to compare it with earlier surveys. I have found some information on an international survey undertaken by the Angus Reid Group and reported in The Economist in August 1998.  The 16,000 adults included in the survey were asked about future prospects for themselves and their children, and the results were used to rank the 29 countries covered according to the optimism of their citizens.  Australia was ranked about the middle (14th).  Respondents in the United States and Britain were more optimistic (ranked 4th and 9th respectively) while those in France and Japan were less optimistic (ranked 28th and 29^th respectively). 

That information is from a review I wrote of a book entitled Measuring Progress, edited by Richard Eckersley. Unfortunately, I have not been able to find the survey report or data table, but the article in The Economist indicates that only a quarter of Japanese expected their children to be better off than they were. That figure lies between the recent I.M. and Pew estimates.

An indication of the way optimism about the next generation changes over time with changes in economic conditions is provided in a review of U.S.data by Journalist’s Resource. Pessimism about the standard of living of future generations fell during the 1990s and has since risen again to levels comparable to those in the early 1990s.

There is not a great deal of comfort in knowing that Australians are not as pessimistic about the prospects for future generations as are people in most other high income countries. The situation could easily get worse with a deterioration in economic prospects in Australia.

It is quite possible that people are mistaken in their pessimism about prospects for future generations, but perceptions can have an important influence on well-being and can also influence attitudes and behaviour. We should know more about why people are pessimistic and whether their perceptions are well founded. Recent reports by the Grattan Institute and the Foundation for Young Australians are relevant to this question and should probably be discussed on this blog in the near future.

Postscript 1:

I have just found my copy of the report of the 1998 Angus Reid Poll referred to above. It was filed away in a place where it was not difficult to find. I am amazed that on this occasion my filing system worked better than Google.

The survey was conducted in May/June 1998. The relevant question was: “all things considered, do you think your children will be better off or worse off than you?”. Apparently 57% of Australians thought that prospects for the next generation would improve, 22% thought they would get worse and 21% thought they would stay the same or were unsure. The corresponding numbers for the U.S. were 78%, 14% and 9%. At the optimistic end of the scale, corresponding numbers for China were 85%, 4% and 11%. Towards the pessimistic end, the corresponding numbers for France were 33%, 52% and 15%; and for Japan, 24%, 59% and 17%.

Postscript 2:
I have just come across some LSAY (Longitudinal Survey of Australian Youth) data which suggests that young people in Australia are optimistic, despite their dissatisfaction with "the state of the economy' and "the way the country is run". In 2013 when their average age was 25.7, 90.1% of the Y03 cohort were happy with their career prospects, 96.3% were happy with their future, 59.9% were happy with the state of the economy and 53.6% were happy with the way the country is run. This group had remained consistently optimistic over the period from 2004 to 2013.

Postscript 3:

My attention has also been drawn to the annual survey of Australian youth conducted by Mission Australia. This captures views of young people on a range of issues, including their aspirations and views on how likely their aspirations are to be achieved. In 2014, there were 13,600 survey respondents aged 15-19 years. Respondents volunteer to take part in the survey in response to an invitation and an electronic link provided via schools.

Aspirations which respondents viewed as highly important (extremely important or very important) included: career success (87.4%); financially independence (86.1%) and home ownership (72.6%). Corresponding percentages viewing aspirations as highly likely to be achievable (extremely likely or very likely) were as follows: career success (55.9%); financial independence (65.5%) and home ownership (71.0%). I am not sure what counts as career success, but those numbers suggest to me that young Australians tend to be pessimistic about their chances of achieving financial independence and optimistic about their chances of home ownership.

Respondents were also asked how positive they felt about the future. In 2014, 63.8% of respondents felt positive or very positive about the future. The corresponding percentages for 2013 and 2012 were 67.5% and 70.6%. 

Why should Australians be concerned about the deficit and debt projections in the latest Intergenerational Report?

Before publishing the latest intergenerational report, Joe Hockey, the Australian Treasurer, said that people are “going to fall off their chairs” when they see some of the graphs in it.

I didn’t fall off my chair. The picture of government debt levels painted by the report is not as bad as I was expecting. The report suggests that under current legislation – the budget measures that have obtained Senate approval – net debt would increase to around 50% of GDP by 2055, slightly higher than the current level in Germany and substantially below the current level in the United States and United Kingdom.

The reason why net debt is not projected to deteriorate as rapidly as I had anticipated is bracket creep – the movement of individuals into higher income tax brackets as a result of inflation.  Bracket creep is projected to result in a substantial increase in the ratio of tax revenue to GDP over the next five years.

Bracket creep is a sneaky way to raise additional revenue. In the past, governments have adjusted tax rates downwards from time to time to compensate for bracket creep, but there is no provision for that to occur automatically under current legislation.

Consideration of bracket creep helps to focus attention on the main problem with government deficits and growing debt levels – namely, the need for debts to be serviced and repaid from government revenue of one kind or another. Some readers might like to remind me at this stage that future Australian governments could follow the example of the Greeks, among others, and neglect to service debts. The downside of that strategy is that if you ever want to borrow again the cost of funds is likely to be much higher, to reflect the risk of default.

The intergenerational report notes that bracket creep can reduce incentives to work, particularly by people on low incomes. This implies that the marginal excess burden (MEB) associated with bracket creep might be fairly high.

So, what is MEB? In broad terms, taxes impose an excess burden or deadweight cost to the extent that aggregate income is reduced by imposing the tax, for example as a result of reduced incentives to work or invest.  (That definition of excess burden is not perfect but it has the virtue of being reasonably easy to understand.) The MEB is the excess burden associated with a small tax increase as a percentage of the additional revenue collected. Thus, for example, a 40 percent excess burden means that for each $1.00 of additional revenue raised, there is an associated deadweight cost of 40 cents. With an MEB of that magnitude, each additional dollar of revenue raised - for infrastructure spending for example - would need to yield a return (discounted to present value terms) of at least $1.40 in order to be worthwhile.

A few years ago the Henry Tax Review commissioned a major study by KPMG (Econtech) of the marginal excess burden (MEB) associated with different forms of taxation in Australia. While the estimates of MEB ranged up to 90 percent, more typical estimates were 40% for taxes on capital income, 24% for labour income, 8% for GST and 2% for municipal rates.

Tax revenue from bracket creep could be expected to involve an MEB somewhat higher than the MEB on labour income. On that basis, the projected increase in tax revenue from bracket creep, equal to about 2% of GDP, could be expected to involve an excess burden of around 0.5% to 0.8% of GDP. That is quite a lot of wealth to be throwing away on top of the deadweight cost of about 6.5% of GDP associated with current levels of taxation.

The obvious way to reduce excess burden is to substitute taxes with relatively low MEBs, such as GST, for income taxes. That would raise concerns that lower income earners might be worse off, but I doubt whether those concerns would be justified if an increase in GST was used to compensate for bracket creep.

The fundamental problem that cannot be overcome by replacing one tax by another to fund high levels of government spending is that MEBs rise exponentially as the tax rate rises. Thus, as shown in the Figure below, if relevant elasticities result in a moderate MEB of 10 percent with a tax rate of 10 percent, the MEB rises to 37.5 percent with a tax rate of 30 percent and to 83.3 percent when the tax rate is 50 percent. I constructed the graph for a report entitled “How Much Government?”, prepared for the New Zealand Roundtable in 2001. The reasoning behind the graph is an application of the standard tools of economic analysis and is spelled out in the report (page 53).

So, what are the implications for excess burden of taxation of the net debt projections in the intergenerational report? The report estimates that the projected net debt of around 50 percent in 2055 under current legislation would involve an increase in net interest payments from 0.7% of GDP to 3.5% of GDP. Under current legislation, assuming an MEB of 40%, there will be an additional deadweight cost of around 1.2% of GDP just to pay interest on government debt. If the government raises taxes sufficiently at that point to eliminate the 6% deficit (underlying cash balance) that would double the additional deadweight cost estimate. Adding on the deadweight cost of bracket creep, gives a total additional deadweight cost of increased taxation equal to about 3% of GDP.

Another way to look at the issues involved is to consider the excess burden of taxation required to pay for the projected increase of government spending equal to 6.5% of GDP - which is the difference between the projected average ratio under the current legislation (31.2%) and the average ratio for the 40 year period 1974-75 to 2013-14 (24.7%). That is the perspective adopted by Henry Ergas in The Australian, March 9, 2015 (article behind paywall). His conclusion is that the required tax increase would cause “a permanent loss of nearly 3 percent of GDP”.

The main reason why the deficit and debt projections should of concern to Australians is that they imply that our grandchildren will have to pay a high cost for government spending that is primarily for the benefit of the current generation. I doubt whether many people would be keen to have the government spend so much money on them if they were aware that for every $1.00 of benefit they receive, their grandchildren would be likely to have to pay about $1.40 plus interest.

  

When you buy coffee and chocolate do you want to know the story about the people who produced the beans?

I bought my first batch of Arabicas Blue Mountain Gold coffee online from Papua New Guinea last year, after sampling the product when I was working in Port Moresby. I was impressed by the flavour, but was also attracted by the story of how this fine variety of coffee - first planted in PNG in the 1930's from seeds imported from Jamaica - is grown mainly by farmers with small plots of coffee trees, using traditional farming methods.

It is not clear to what extent the farmers actually benefit at present from marketing telling that story, but there must be potential for them to obtain greater rewards in future if the combination of a good story and a product of consistently high quality leads to growth of demand for their output.

Before spending a couple of weeks in PNG recently I told people who asked why I was planning to have a holiday in such a dangerous place (please see my last post for an attempt to put those risks in perspective) that one of my reasons for visiting was to see where my coffee came from. As things happened, I didn’t actually get to see where my coffee came from, but I did see a coffee plantation near Goroka. The fruit shown in the photo will turn red over the next few weeks before being ready for harvest.

I also had the opportunity to visit a processing facility in Goroka and to learn a little about the industry from the manager of the firm. He has asked me not to give him any publicity because his firm does not sell directly to the public and gains no benefit from any time he spends showing tourists around. I was fortunate to arrive on his doorstep just as he was about to show his operation to a group of bank officials and to be allowed to tag along.

 It was interesting to see the effort required for quality control, particularly in order to give purchasers of organic coffee (usually grown on small holdings) a high quality product. For example, quality is better when care is taken to only pick ripe fruit and to ensure that beans are properly dried in the sun. If the beans are not dry when they come to the mill they have to be dried using equipment such as that shown below.

The factory tour ended with a coffee tasting which demonstrated large differences between various grades and blends of coffee.

 During my PNG holiday I also visited Madang and had the opportunity to see cocoa being grown. The Madang Resort hotel organised for me a trip to Hobe, a small village not far from Madang. I spent an hour or so with Joel Lalek on his cocoa farm. 

Joel described himself as a subsistence farmer, but his cocoa activity looked fairly commercial to me. His crop is fermented and dried by his brother using the equipment shown below.

Joel buys seedlings from the Cocoa Coconut Research Institute (CCRI).  The photo below shows seedlings at the Stewart Research Station, CCRI.

The research manager of the Stewart Research Station explained to me the origins of PNG cocoa and the aims of the current breeding program. PNG cocoa is based on the Trinitario variety, often used in high-quality dark chocolate. Unfortunately, the variety is susceptible to cocoa pod borer, which has devastated harvests in PNG during the last decade. One of the aims of the breeding program is to provide greater resistance to this pest. Meanwhile, farmers in some areas have had considerable success in controlling pest outbreaks through pruning and sanitation practices e.g. burying diseased pods. 

A question I was turning over in my mind during my PNG visit is why I haven’t found the same opportunities to obtain single source chocolate based on PNG cocoa as I have to purchase PNG coffee. It would be good to be able to find a regular supplier of high quality dark chocolate with a PNG village story attached to it.

It seems likely that better opportunities to buy single source PNG chocolate might arise in future. People who live in the US can already buy chocolate made from PNG beans from Tejas Chocolate. Perhaps the partnership between Cadbury Australia and Monpi Cocoa Exports will eventually provide similar opportunities to Australians.

It would be nice to be able to end this article with some optimistic observations about the opportunities for better returns for coffee and cocoa farmers in PNG arising from the increasing demand of consumers in high income countries to be told the story behind the food and beverages they buy. I have not found any research which would provide a solid basis for such optimism, but I have not spent much time searching the relevant literature. All I can offer at this stage is a glimmer of hope.

It is indisputable that many consumers like to know the story behind some of the products they buy. Wine comes to mind as a prime example. Yet, in recent years we have seen a trend toward commodification of wine sales in supermarkets, with the use of hidden labels and own-brands. That trend is presumably meeting a demand for a product of reasonable quality at a relatively low price. The trend toward commodification may continue for some time, but when people are buying high quality wine they will still look for a label which tells the story of when, where and how it was produced. I guess the pattern of demand is fairly similar for coffee and chocolate.

The characteristics of farming in PNG typically meet a range of the interests and concerns that people are likely to have when they want to know the story behind the products they buy. The fact that the varieties of coffee and chocolate grown in PNG are at the high quality end of the market certainly provides a basis for positive stories. The fact that chemicals are rarely used by village farmers helps to meet some consumer concerns about health and environmental impacts. Telling a story about village farming can also be consistent with marketing arrangements which help meet the concerns that many consumers have about remuneration for farmers.

Most importantly, the stories that PNG farmers can tell are intrinsically interesting because their lives are so different from those lived by most people in high-income countries.

So, dear reader, when you buy coffee and chocolate do you want to know the story about the people who produced the beans?

Is Papua New Guinea a safe place for tourists to visit?

My short answer – based on my recent two weeks holiday – is that it is safe for tourists to visit PNG, provided they take sensible precautions.

As I wrote that sentence I was sitting in the terminal at Nadzab airport, fully aware that it had been the scene of a holdup by a group of 30 armed men a couple of months ago. I am not a particularly intrepid traveller, but I felt safe, given the number of people in the terminal – about 100 in the Airlines PNG area where I was sitting - with quite a few security guards not far away.

 

At the time of the hold-up, government officials claimed that Nadzab airport, which serves Lae - the second largest city in PNG - is not much used by foreign tourists. That claim is probably true. During the five hours I spent in the terminal I did not see many people who looked like foreign tourists.

However, it seems odd to me that there are not greater numbers of foreign tourists passing through Nadzab airport. Lae seems to be well located to be a natural hub for air travel, as well as for land and sea transport. Perhaps the accidents of history which made Port Moresby the administrative centre of the country have impeded the development of Lae as a hub for air travel.

My sojourn in the terminal at Nadzab airport occurred in the latter part of my visit to PNG. I spent a more enjoyable day looking around Lae earlier in my visit. Of the places I visited in PNG, Lae is probably the least safe, but the security available there seemed more than adequate. The streets of Lae appeared to be quite peaceful through the grill on the windows of the Guard Dog Security vehicle that took me to and from the airport and around Lae.

I had not expected any problems in finding a tourist operator to take me to places of interest to me in Lae. However, the operator I was referred to told me that city tours had been discontinued because tourists had become an endangered species. Reception staff at the Melanesian hotel arranged for Guard Dog Security to take me to the places of interest to me - the Lae War Cemetery and Rainforest Habitat - for a reasonable fee.

The war cemetery is well worth visiting, particularly for those, like myself, who have relatives who fought on the Kokoda track. The cemetery is well-maintained by the Australian government. At the time of my visit, there were no other visitors present. I was given a great deal of help to find the names of my relatives, but the lack of other visitors is a sad commentary on the state of foreign tourism in Lae.

The Rainforest Habitat was worth visiting to see some of the local birdlife, even though I didn’t get to see a bird of paradise. The security man who accompanied me said that there had been more to see at the facility a few years ago. Apparently too few people are visiting to generate the revenue required for the facility to be properly maintained. While I was at this tourist attraction I think there was only one other visitor there.

The other places I visited were Port Moresby, the capital, Goroka, in the Eastern Highlands, and Madang, on the north coast. Port Moresby is less safe than the other two towns.

It is unsafe for tourists to walk around most parts of Port Moresby alone except within the boundaries of major hotels, modern shopping malls and other locations where security is provided. The same applies to local residents. Tourists are more fortunate than most of the locals because they can afford to be transported safely from one secure area to another.

I had no hesitation in relying on taxis for travel in Port Moresby during my current visit. As a foreigner I had expected to be charged more than locals, but that didn’t happen when staff at Holiday Inn negotiated with the taxi drivers on my behalf. Disputes were avoided by negotiating the fare prior to travel and ensuring that the driver had change available for large notes when that was required.

Tourist guides suggest that some taxi firms in Port Moresby are more reliable than others but, as far as I am aware, there is no taxi firm that is sufficiently safe to be recommended for women to use to travel alone at night.

Port Moresby has tourist attractions that are well worth visiting during daylight hours, including the National Museum and Parliament Haus (see below).  It is possible for tourists to visit these places without much risk to personal safety.

When I arrived in Goroka, the bus from the Bird of Paradise Hotel was not there to meet me. Perhaps the plane arrived early. In any case, Peter Samuel, a young man whom I had just met on the plane, offered to walk with me to the hotel which would have been no more than a couple of hundred metres from the airport terminal. Peter saw me safely to the hotel, but as I was walking with him along the street shown below, the thought occurred to me that if I was advising another traveller in that situation, I would have suggested that they should ring the hotel and wait to be picked up.

Peter Samuel and I exchanged phone numbers and he later sent me this message:

“Please, when you are in Australia remember me and give my phone number to one of the Australian Girl to get Courtship with me”.

I don’t normally do this kind of thing, but if any young women reading this would like to get in touch with a young man from the Eastern Highlands of PNG, who has shown kindness to at least one stranger, I am willing to pass their phone numbers to Peter.

I felt safe walking around Goroka by myself, but obtained the services of a guide to visit a coffee plantation (which I will write about in a subsequent post) and to visit the Saturday market which is a short walk away from the town centre. I was impressed by the fresh vegetables on sale at the market.

In Madang I stayed at the Madang Resort, a magnificent hotel, at the gateway to the harbour and close to the town. The hotel arranged a trip to a local village for me to see a cocoa being grown. I will write more about that subsequently.)

As in Goroka, I felt safe walking around Madang during daylight hours. I felt particularly safe walking around on my second day because a cruise ship, Pacific Dawn, was docked in the harbour for the day.

It was particularly interesting for me to compare my experience wandering around by myself with the experience of a couple I met from the cruise ship. The photo shows Tania and Peter with a couple of ladies from the Country Women’s Association (CWA), who had just sold them some new hats.

Cruise ships seem to be an ideal way for people to see coastal towns in safety and to experience organised sight-seeing and cultural experiences. The downside for people on the cruise ships is that they don’t get to see the highlands and don’t have as much interaction with local people. The photo shows the Pacific Dawn leaving Madang harbour.

In my view the risks in organising my own itinerary to travel around PNG were minimal because I was able to stay in good hotels and to pay people to accompany me when necessary. Despite PNG’s reputation as a dangerous place to visit, many of the people I met went out of their way to protect my safety, as well as to make me feel welcome.  

Is there reliable evidence that people can learn to be happier?

There is plenty of evidence that people who use cognitive reappraisal strategies -  for example, changing the way they think about situations in order to reduce negative emotion – tend to have higher life satisfaction than those who try to suppress negative emotion. There is also a growing body of research findings that such skills can be learned and that some reappraisal strategies are more effective than others.

A recent study by Bryan Denny and Kevin Ochsner compared the effects of training using two common variants of reappraisal: distancing and reinterpretation. Distancing involves reappraisal of an emotional event by viewing it from the perspective of a third person observer or an objective, impartial observer. Reinterpretation involves reappraisal by changing the meaning of actions, context or outcomes e.g. by inventing a more positive story to interpret the event.

The 103 participants in the study were divided into three groups: on receiving training only in distancing; one receiving training only in reinterpretation and a third group that was asked to respond naturally to stimuli, but not trained in any form of reappraisal. The training was provided in four sessions separated by 2-5 days. Participants were presented with images and asked to let themselves respond naturally. Those who had been given reappraisal training were also asked to reappraise images.

Both distancing and reinterpretation led to drops in self-reported negative emotional responses over the four sessions. Participants in the distancing group also experienced drops in negative emotional response when they were asked to respond naturally. The results suggest that people can learn to make distancing a habitual response to emotional stimuli during a relatively short training course.

In another recent study Rachel Ranney, Emma Bruehlman-Senecal and Ozlem Ayduk compared the impact of three brief online cognitive reappraisal interventions: self-distancing (watching a personal negative experience as a fly on the wall); temporal distancing (considering the event from the perspective of their future selves); and positive reframing (identifying positive aspects of the experience). The results showed training in temporal distancing to be effective in raising well-being and positive reframing to be effective in reducing ill-being.

I went looking for evidence that people can learn to be happier to follow-up my preceding post about regret. I concluded that post by resisting the temptation to suggest that people who suffer from regrets that do not serve a useful purpose should learn cognitive retraining. At that stage I was not able to cite reliable evidence that such training was effective. Having found some evidence, however, I am not still not sure how effective it would be in dealing with regrets.

If someone regrets a bad choice made a long time ago, temporal distancing is unlikely to work. Viewing the choice as an impartial observer might not help either if it was a really bad choice. Positive reframing could help the person concerned to see something positive in the experience – for example, it could be seen as a learning experience, inducing positive changes in personality. Such reframing is likely to be difficult, however, if the person concerned believes that personality is fixed for life.

There is evidence that the implicit theories that people have about the extent to which attributes such as personality can change has important implications for their mental health. A recent study by Hans Schroder, Sindes Dawood, Matthew Yalch, Brent Donnellan and Jason Moser has shown that people who believe that their attributes can change report greater use of cognitive reappraisal and fewer mental health symptoms. This raises the question of whether people who currently believe that their attributes are set in stone are capable of learning to adopt a mind-set more conducive to improvement.

If your satisfaction with life is adversely affected by regret, what should you do about it?

The purpose of feelings of regret is presumably to help us to make better choices. That suggests that the best way to deal with regret is to make sure we make better choices in future. But regret can also put people into a frame of mind where they make poor choices and find it difficult to enjoy of life.

Regret does not feature prominently in conventional economic theory, even though everyone knows that sensible people take into account the potential for regret when they make decisions.  I suppose that is because Max U, the rational economic man of economic theory, does not let potential for regret prevent him from seeking to maximize utility. Even when economists allow for the possibility that Max might feel losses from the status quo to a greater extent than gains (as in prospect theory), the potential for disappointment and regret still does not come into consideration in the choices he makes.

It is normal for humans to feel disappointment when outcomes are worse than expected – for example when an investment fails even though we have good reasons to expect it to succeed. We feel regret about the opportunities we have foregone in making such investments. Regret is likely to be particularly intense if you mortgage your home to fund an unsuccessful investment.

It usually makes sense for people to take account of the potential for regret in making choices. It is also possible, however, for regret to lead people to make poor choices – choices they later regret. For example, when share prices slump, people who are unduly influenced by regret about the losses they have experienced may decide precipitously to reallocate funds to less risky investments, and later regret that they have sold at the bottom of the market. Alternatively, they may gamble to recover past losses (for example, by buying more shares) and come to regret that choice if the market falls even further. Some economic studies, for example theoretical and experimental work by Philip Strack and Paul Viefers, illustrates the potential for regret to influence decisions in this way.

There is some evidence that regret can have a large impact on life satisfaction. The results of a recent study by Olivia Pethel and Yiewei Chen seem particularly interesting, since these authors use a measure of the intensity of regret, in addition to indicators of negative decision outcomes and the tendency of people to feel regret. The study focuses on mature adults, people over age 35, who are old enough to have had opportunities to make decisions which they might regret. The findings of the study should probably be viewed with caution because of the small size of the sample (119 adults) sex composition (71% female) and the potential for bias in the informal sample selection process that was used.

The regret intensity variable used in the study was constructed by asking people how much they regretted having made wrong choices in various aspects of their life on a 5 point scale (1 = no regret; 5 = very strongly regret) and averaging across the scores. The results of the regression analysis suggest that “very strongly regretting” a wide range of choices in life would be likely to have a large impact on life satisfaction – reducing it by about 1.6 points on the 7 point scale used in the study.

The authors suggest that people who have lower levels of regret intensity may have developed effective emotional regulation strategies in dealing with life regrets. Unfortunately the study does not directly test the use of regulation strategies.  However, the regression results support previous findings that cognitive reappraisal - use of emotion regulation strategies that change the way situations that elicit negative emotions are viewed - has a positive impact on life satisfaction.

I will resist the temptation to conclude that everyone should be taught the bygones principle - much loved by economists - that decisions should focus only on future costs and benefits, leaving aside regrets about the past. In my experience, the bygones principle is much easier to apply to public policy than to one's private life. 

I will also resist the temptation to conclude that people who are allowing regrets to interfere with their enjoyment of life should learn cognitive reappraisal skills. It would be easy to draw upon my own personal experience to suggest ways people might be able to acquire such skills, but at this stage I can't cite reliable studies testing what works and what doesn't work.

Does it make sense to think of trade-offs between life satisfaction and wealth?

Before you answer the question, I would like you to conduct a couple of thought experiments.

The first step is to answer the following question:

All things considered, how satisfied are you with your life these days? Please give your answer as a number between 1 and 10, with a rating of 1 is you are dissatisfied and 10 if you are satisfied.

That is a standard question that has been asked by happiness researchers. Now we come to the thought experiments.

Thought experiment 1:

Imagine that your circumstances suddenly change so that it becomes possible for you to increase your peronal life satisfaction rating by 25% if you are prepared to sacrifice some wealth. What is the maximum amount of wealth that you would be prepared to sacrifice in order to achieve an improvement of 25% in your life satisfaction rating?

Don’t worry if the 25% improvement would take you beyond the top of the rating scale. For the purpose of this exercise it is deemed to be possible to increase your life satisfaction beyond the end of the scale e.g. from 10 to 12.5. That makes sense because people who are completely satisfied with their lives sometimes find that their lives get even better.

Thought experiment 2:

Now imagine a different scenario. Your circumstances change so that it becomes possible for you to increase you wealth by 25% if you are prepared to sacrifice some personal life satisfaction. How much life satisfaction would you be prepared to sacrifice in order to achieve a 25% increase in wealth?

My guess is that in answering the first question there are not many people who would be prepared to sacrifice all their wealth to obtain a 25% increase in life satisfaction. In relation to the second question I don’t think there would be many people who would be unwilling to sacrifice any life satisfaction (if only for a limited period) in order to obtain a 25% increase in wealth. Those are just my guesses. If large numbers of people tell me that I am wrong, I will have to admit that I have made a mistake.

What is the point of this exercise?  Some economists have been prepared to assume that the sole aim of individuals is to maximize life satisfaction as measured in social surveys. That might seem to be a reasonable assumption until you think of the implications. If your sole aim is to maximize personal life satisfaction it would be irrational not to sacrifice all your wealth in order to obtain greater life satisfaction, if that possibility became available. Similarly, it would be irrational to sacrifice any life satisfaction under any circumstances to obtain greater wealth.

If the choices that people make imply that they do not aim to maximize life satisfaction, that doesn’t mean that they are irrational. It just means that there are some things more important to them than life satisfaction, including some things that money can buy.

What could be more important to people than life satisfaction? Some clues are offered by research, discussed here a couple ofmonths ago, which asks people to choose between hypothetical situations with different ratings of life satisfaction and other well-being indicators. 

The people surveyed indicated a stronger preference for options offering high overall well-being to you and your family than for life satisfaction. Other well-being indicators ranked above life satisfaction included personal health, being a good, moral person and living according to personal values, the quality of family relationships, financial security, your mental health and emotional stability, a sense of security about life and the future, having many options and possibilities in life and freedom to choose among them and a sense that your life is meaningful and has value.