Monday, October 03, 2011

Tax reform (Part 2)


The smh yesterday had an article written by Michael Pascoe on the pending fiscal doom of Australia.
The demographic shock of the retiring baby boomer horde, the soaring health inflation rate, the urgent need to lift our education investment to at least the OECD average and bringing our transport infrastructure up to speed all require someone to pay for them. And, no, there actually isn't a Hockeynomics Magic Pudding that will provide for everything by cutting back on a few existing government programs.

Read more: http://www.smh.com.au/business/markets/a-surplus-could-do-australia-more-harm-than-good-20111001-1l2q1.html#ixzz1ZgOXkRW8


What is curious about this article is the lack of inclusion of Australia's super wealth in the whole doom and gloom. Australia currently has one of the largest pools of superannuation in the world with $1.34 Trillion according to APRA. I thought this money was for people's retirement income. When you look at the nitty gritty detail of pensions and standards of living it becomes very complex. For some reason, people are retiring in Australia at 57 or 58 but have very small super funds to do so. These people won't qualify for the pension until they're 65 so why are they doing this?

However, a macro policy debate has to be based off macro data and if you think that this $1.34 Trillion barely existed 30 years ago and is expanding every year then surely some of the fiscal strain of the baby boomers is removed. It seems however that the debate never considers that an eventual draw down on this lump sum is a favourable thing whereas my view would be this was the whole reason for it. As more and more baby boomers retire, more and more of them will start to draw down on their super and with less work force adding to the number, the total value will decline. Any decline in the value of super through this process is a direct positive to the fiscal situation which would have made up this gap if the money didn't exist.

The total paid in pensions in 2011 is $40.7bn. So, it would be possible to pay this amount out every year for 30 years and still have money left in the kitty even if no further payments were made into super and no income from that super was obtained. This would take us up to 2041. The fact that more super contributions are going to be made and that income will be made (hopefully) on the money invested means that it is theoretically possible to pay the current pension out of super reserves for the next 50 years. The pension however, is expected to double over this time period. So we could theoretically maintain the current level provided by the government and draw down the rest through super. 

Unfortunately, superannuation has not provided the answer as this $1.34 Trillion is not evenly distributed across the population (check out the median versus mean in this publication by the ABS) and is a large contributor to what will become a worsening Gini Coefficient unless of course the government in 20 years time decides to tax this pot of gold and re-distribute it to those who did not accumulate super from those who did. Hmmm sounds like there is a magic pudding for the offering.

Tax reform

Tax reform is THE topic in business and economics conversation at the moment. Europe is going through hell trying to re-balance various countries balance sheets, the US has blown out its budget trying to keep the economy from dying a dramatic death and now seems determined on using fiscal austerity to reverse this attempt as all the stimulus did was create stagnation (seems like hell is better than purgatory). Here in Australia, having a strong fiscal balance sheet and very little economic problems we've been inventing them and not wanting to be left out have created our own tax summit to be held this week in the lovely Canberra.

As per my previous post, I've been impressed with the amount of dodgy facts that have been presented by a variety of sources for each element of the tax and spend reviews that are busily being performed. Probably the highest profile of these is Warren Buffet's cry that the rich should be taxed more and that it is an outrage that he pays less tax than the average salary earner. Now, I don't have much issue with the possibility that the rich should potentially pay more tax. The Gini Coefficient in the US has been getting worse and worse over the past 40 years  and tax redistribution is the best way to make this trend decline. However, one of the knight in shining armour's claims is that he pays less tax than the average salary earner. He says he paid only 17.5% on his income last year. Is this true?

The answer is no and he must know this. His income comes from investment. Personal income from investment whether it be dividends or capital gains in America is taxed at 15%. However, this income is derived from the income generated by the investments made. These investments (mostly in companies) pay their own tax and hence their value is reduced by the taxes paid. If (as the Economist magazine has recommended) company tax was abolished then the value of all shares would rise significantly. Hence, Mr Buffets income would rise significantly. This means his current income is reduced by the taxes paid by the companies he invests in. As the company rate is 35%, you could add this to the 15% already paid and you would be closer to the true tax rate of Mr Buffet; that of 50%.

What is interesting is that while this obvious error is pointed out in this Forbes article, confusion then reigns in the comments and in his attempt to correct errors that aren't errors. More interestingly still is a different article that is trying to argue against Mr Buffet assertions to tax the rich more but accepts his statement of 17% and argues against the % on his receptionist/secretaries income (a trivial argument, who cares if its 31% or 29% it is still higher than 17). If an article trying to argue against the assertion misses the most obvious point then how are people ever going to know the real facts and lobby politically for the right tax outcomes? What chances for a decent outcome in Australia this week at the tax "forum"?

Quantitative decision making, stakeholder influence and gut feel

For a long time now I've pushed the benefits of modelling to aid in decision making. It was never believed that modelling would result in 100% accuracy and that decision makers would not need to make decisions based off judgement or gut feel, just that a well modelled business case would make this judgement a more informed one and hence more likely to be the correct one. Even with the push for long term and triple bottom line analysis, it was always understood that this analysis played a supportive role.

This passion for investment analysis has led to our business case training course being delivered to over 1,000 attendees since 1999. However, of late, I have found that facts are ever increasingly hard to come by. The internet and enterprise search allows for verification of statements in a second. Using these tools to verify statements made in business cases invariably leads to the identification of falsehoods rather than the verification of facts.

I still believe that a well modelled and fact based business case can greatly improve the performance of both business and government, I am being more and more disillusioned with the use of erroneous facts and robust yet erroneous business cases being used to justify what is essentially a gut feel decision (i.e. make the facts bend to the decision that's already made rather than explore the options and decide after the analysis is presented).

What is also disappointing is the periodicals and people who are using this "make the facts meet the story" method in justifying their statements. In the next few blog entries I'll highlight some of the more recent blatant factual errors used to justify some policy or business decision making reason. Included in these will be statements made by Sage of Omaha - Mr Buffet, the Economist, Michael Pascoe of the SMH and some You Tube videos I've watched recently. Hopefully this will help clear the head and get the frustration out of my system.