Income inequality - a cause for concern?

In Australia the degree of income inequality is increasing. That's what the data tells us, although frustratingly 2012 is the last year for which we have reliable data.

That data shows that the Gini-coefficient for Australia has risen by a greater degree than in all but two other OECD countries. This in a period when, by the same measure, around half of OECD countries saw a more even distribution of income, but with a slight rise in inequality on average.

A survey reported in The Guardian says that most Australians feel that inequality has become worse and that it harms society by creating social division.

The chart gives a summary of Australia's income and wealth.

Recall that income is a flow concept, it shows how much money households receive each month or year, whereas wealth is a stock concept, it shows the assets households have accumulated over time. The two are related as unequal distribution of income will generally mean that wealth will accumulate to high income households who can afford to save, while poorer ones cannot.

How to deal with income inequality is a matter of debate, as is the idea of what a 'fair' distribution of income is. The survey shows there is little agreement on how to proceed, although typically for Australia they do agree someone other than themselves should bear the burden. Perhaps surprisingly there is significant opposition to an estate duty (inaccurately called an inheritance tax in the article) which taxes you when dead, rather than when alive. It has much to recommend it.

The Guardian reports the survey here

The goal of income distribution is downgraded in importance in the 2017 VCE study design, but is still very relevant. IB students can be asked an essay question on this in Paper 1 and policy measures are an essential part of that.

Negative gearing - does it lower rents?

'Negative gearing' is a scheme in Australia where a landlord can make a loss renting out a property and set that loss against their other income so that they pay less tax. For example a landlord collects $100 a month less than the cost of a properties mortgage and expenses. The landlord earns $100 a month from other work, but pays no tax on that income in compensation for the loss. Only three countries in the world allow this and Australia is one of them.

The 'tax incentive' allows people who buy property as an investment to earn higher profits from that investment in the long term. It is widely criticized as causing a less equal distribution of income as the benefits go to those who can afford to own more than one property. There are a substantial number of investors who own multiple rental properties.

Those who defend the use of negative gearing claim that it helps lowers rents for those who cannot afford to buy their own home. This is because it allows landlords to rent at a loss.

The economics of this can be explained using demand and supply.

 

Figure 1

Figure 1 shows that as the cost of buying a rental property is now lower, the supply curve of rental homes shifts to the right (S to S1). The market equilibrium rental price falls from 0P0 to 0P1, while Q1 - Q0 more homes are rented out at the new market rent, P1. It seems that renters share in the good fortune of the tax break given to investors.

The problem is this isn't really all that happens. It is a complex situation and we will focus just on the housing market. The fact that landlords can now recoup part of their loss on an investment means they can afford to pay more for any given property. This raises the demand for housing and, given that the stock of homes is very limited (inelastic supply), we can expect this to drive up the price of homes. Figure 2 shows how the effective subsidy for landlords shifts the demand for homes from D1 to D2, that leads to a rise in the price of homes to 0P1 from 0P0. The inelastic nature of house supply means that the price rise might be quite significant compared to the demand shift.

 

Figure 2

The result of this rise in the price of buying a new home means that landlords costs are higher than they would otherwise be, wiping out at least part of the gains from Figure 1 (S1 does not shift as far to the right). Further the higher price of buying a home means more families have to rent as they cannot afford to buy. So the demand for rented accommodation in Figure 1 shifts to the right, resulting in higher rents.

It is therefore not at all clear that negative gearing helps renters. It certainly reduces the tax bill of landlords however and that makes it difficult for weak politicians to tackle the problem. There is no doubt in my mind that negative gearing represents an unjustified transfer from taxpayers generally to landlords and helps skew the distribution of income towards the higher income deciles of Australian society.

The ABC explain why the scrapping of negative gearing wont push rents up and some of the history of the tax concession in the article below.

The ABC article is here

This article is relevant to VCE students for Unit 4, budgetary policy and for the goal of equity of income distribution. It is relevant to VCE and IB students as an application of supply and demand analysis using elasticity and an example of government failure in their intervention in a market.

Tax reform is a current issue

The Australian government has a budget problem. It's not always the problem they claim it to be so quickly here are the key problems:

1. The government does not raise enough money.  All budgets are a balance between income and revenue. Presently there is a budget deficit because successive Australian governments cut taxes and allowed some groups to have tax concessions which are politically difficult to remove.

2. The population of Australia is ageing. This will lead to the need to higher government spending in the future on services such as health and on benefit payments, such as pensions. There is also the likelihood that the working population will shrink, meaning fewer workers are available to pay the tax needed to raise revenue.

3. Commodity prices are falling. Australia relies on commodity exports to maintain its standard of living. The collapse in iron ore and coal prices means both Australia income and government tax revenue is falling.

Therefore action must be taken to establish a guaranteed revenue stream for the government. Reforming Australia's appallingly complex tax system, which has many built is advantages for vested interest groups, is essential. Everyone agrees on this point!

Th problem for politicians is that they can loose support if they upset voters by asking them to pay more. Therefore they are reluctant to make the tough calls.

One suggestion is that GST is raised to 15%, making everyone pay more. There are pros and cons.

Pros: GST is difficult to avoid, you pay it as you spend. It is cheap to collect, firms do a lot of the work for you and raising the rate makes little difference to collection costs. People don't notice when they pay it, it's in the price, so you get fewer complaints.

Cons: The tax is regressive. That means that the burden falls more heavily on the lower paid (lower income quintiles/deciles of the population) and so works against the goal of equity. If placed on goods with external benefits (positive externalities) it makes market failure worse.

An additional point is that if not applied equally on all goods it changes relative prices. Therefore goods without GST become more attractive to consumers and more resources are allocated to them, with fewer resources going to taxed goods. (This is how taxes work!) However an inefficient allocation of resources can result while the government are trying to do the right thing.

The Treasurer, Scott Morrison, is struggling with all of this as he prepares his first Federal Budget. He is concerned, according to the article below, with the effect of GST on Education and Health. Both are 'Merit goods' and they have external benefits. We wish to encourage increased consumption of both, not reduce consumption through tax.

The ABC cover the story here.

How Australia deals with the 'Budget crisis' is going to be a vital topic for VCE economists and a case study for IB students.

Questions.

1. What is the effect of raising GST on the distribution of income? (Goal of equity)

2. How does putting GST on health differ from putting GST on education? (Hint. Only private education will attract GST.)

The goal of equity. Gone but not forgotten?

Understanding the impact of the budget on output, employment, growth and the Current Account is very important. But what about the other goals? Equity for example.

The Budget seemed regressive in nature when it was announced. The poorer quintiles/deciles appeared to be loosing most and paying more too. Now research (technically modelling by the Treasury) has confirmed this.

Unfortunately the original story in Fairfax media is behind a pay wall, so I have linked to the Guardians shorter story. 

Notice the defence by the Fat Controller, that the tax system is progressive so the rich pay more. He misses the point, the report is about the change in equity, not the overall effect. Poor Joe.

The Guardian story is here.

Budget reflections

While we will look in detail at the Federal Budget in Unit 4 there is a continuing stream of comment that raises points to note.

Below is a link to Ross Gittins latest effort. (You need to remember he is a journalist not a trained economist and sometimes gets the wrong end of the stick.)

In this article he points out the extent of the measures in cutting expenditure, the reliance on bracket creep (fiscal drag) to raise revenue and the redistribution effect from poor to rich (goal of equity).

Perhaps his most important point is that the implications of this Budget is that in the not to distant future the measures would have to be reversed because the implications are so grave. Note his point on ideology are not for repeating in the exam.

The Gittins article is here

As an add on there is an excellent article in The Guardian that explains what the true level of Australia's national debt is. The article also explains the importance of using real figures as opposed to gross figures and using figures as a percentage of GDP when trying to properly understand the debt position.

There are some neat interactive graphs to play with too!

The Guardian article is here

Inequality - a key goal that always gets a low priority?

The VCE study design insists that equity is a goal of government policy. In Australia it has always been a matter of pride that income distribution is more equal than other developed countries, but since the 1980's policy measures have not really backed that up.

The coming Federal Budget is likely to make the distribution of income less equal, particularly if the petrol excise duty and GP visit co-payment is introduced. However the discussion of the Budget will be dominated by its affects on other goals I suspect, so dealing with it now might be opportune.

Inequality is measured by the Gini co-efficient. The table below showshow Australia compared in the 'late 2000's'. Although a Gini co-efficient of 0.33 isn't too bad at all compared to the 1980's it is about 20% more unequal (Australia would have been in around the same position as Hungary on this graph.

 

The article below from The Age explains the likely impact of a number of proposed Budget measures. We shall return to them when we look at the goal of equality later.

The Age article is here

Time to start the debate on tax?

The government worries about the size of the budget deficit and is going to take steps in the Budget to fix that. The problem is that short term changes won't fix a long term structural problem.

There are two ways to balance a budget.
1. Cut government spending
2. Raise more revenue through taxes.

Let us suppose that over time a government aims to balance its budget. That is it spends as much as it raises so there is no net addition to the national debt.

This does not mean that in each financial year the government will balance its budget. It actually means in years of low economic activity they will borrow (to boost the level of national output) and in the years at the top of the economic cycle they will run a surplus to repay debt. The result is a balanced budget over the economic cycle.

The problem for Australia is that they are borrowing in most years, resulting in a budget deficit over the economic cycle (known as a structural budget deficit). Although as the chart below shows Australia has no real debt problem compared to other nations.

Australia does not tax its citizens much either when compared to other developed countries (26.5% of GDP compared to an OECD average of 34.1% in 2012). It also has a fantastically complicated tax system which sees most people getting tax rebates each year.

A solution is to expand the tax base by taxing more things and doing this in a simple, non-refundable way. That is by taxing spending, not income. In Australia this is done by using the Goods and Services Tax (GST).

There are two ways the GST can raise more money.
1. Put the rate up from 10%.
2. Extend the range of goods and services GST is applied to.

The advantages of GST are that it is pretty difficult to avoid, so raises a lot on money and is simple to administer.

The disadvantage is that it is a regressive tax. The poor pay a higher proportion of their income in GST than the rich. It is not as easy to compensate the poorer households for this (while it is easy for income tax) and so it adversely affects the goal of a equity in the distribution of income.

Martin Parkinson, the Treasury Secretary spoke about this possibility yesterday here