Jim Chalmers has claimed that hiking CGT is the “right decision” done for the “right reasons”. Of course, one might be forgiven for wondering why they did not take such a decision to the election and why it is fine for a government to lie to get elected. But, let’s look at whether it even is the “right decision”.

The most frequently mentioned change is a reversion of CGT rates to the indexation method. This would adjust the capital base (i.e., purchase price, and presumably additional works) with inflation. The tax would then be on the real returns. It appears there will be partial grandfathering. Negative gearing also looks set to be eliminated.

There are several fundamental issues with the CGT hike.

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Some politicians, such as Senator David Pocock, have called for a 25% tax on gas exports. However, commodities companies, and the Business Council of Australia, have warned that such an export tax would jeopardize Australia’s supply, and raise little – if any – revenue.

So which is it? Well, it turns out that when you model the impact of an export tax, the results are profoundly negative.

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The intuition is straightforward an export tax renders marginal production uneconomic and deters exploration. Oil and gas production curves are stepped. This means that we have different types of production, with different cost bases. And, only so much supply is available at cheap prices. For example, we might have cheap onshore, expensive offshore, and unconventional production. If the price received consistently falls below the breakeven point for a production type, it will cease.

The impact of an export tax is therefore obvious: where the export tax reduces the price received below the breakeven point for a technology, that technology simply stops being utilized. In so doing, it reduces (or eliminates) exports, causing the export tax to raise less revenue than claimed. Furthermore, by reducing production and corporate profits, corporate income tax falls. Most gas companies do indeed pay export taxes. For example, Santos’s tax rate was around 22% of its gross profits (cf Net Income), and 31% of its profits before tax.

Let’s use oil prices, to which natural gas is largely benchmarked, for clarity of discussion. Oil prices are a convenient benchmark because they are relatively standardized across countries. So, in round numbers, ‘cheap’ production might be viable at a price of USD 30/barrel, mid-tier production viable at a price of USD 50, and expensive production at a price of USD 80. Clearly, the expensive production would be difficult to get off the ground as world oil prices frequently dip below USD 80/barrel, even if they are currently hovering near USD 100. The problem is obvious, if there is a 25% export tax, then the price received will be too low to justify ‘expensive’ production types. This tautologically limits the amount of oil that would be produce. The logic applies mutatis mutandis to gas or any other commodity. An example of what this might look like is below.

Figure 1: Supply and Demand, and welfare effects of a 25% export tax. The stepped supply curve reflects three production tiers with breakeven prices at $30, $50, and $80/bbl. Before the tax, the world price of $100 supports 110 units of supply, 70 of domestic demand, and 40 units of exports. The export tax drives the domestic price to $80 (the autarky equilibrium), eliminating Tier 3, contracting supply to 80, and absorbing all output domestically. Area A represents the consumer surplus gain; areas B and C represent consumption and production deadweight loss respectively. The hatched region denotes stranded Tier 3 capacity.

Because export taxes significantly alter potential supply, it turns out that the optimal export tax rate is in single digits. But, only if we ignore the inherent risk and volatility associated with commodities and the negative signal an export tax sends to businesses. For example, using a partial equilibrium model, we find the below ‘fiscal Laffer curve’, with export tax revenue being optimized at an export tax rate of around 10%, but total net revenue being maximized at an export tax rate of around 4%. Indeed, depending on production quantities, an export tax can indeed eliminate exports, which causes the export tax to raise precisely zero revenue.

Figure 2: Export tax sensitivity: Each panel shows the response of a key variable to export tax rates from 0% to 50%, holding the world price at $100/barrel and the corporate tax rate at 30%. The vertical dashed line marks the export-killing threshold ( 20%), beyond which the economy enters autarky. Panel (a): effective domestic price. Panel (b): export volume. Panel (c): export tax revenue, which peaks at approximately T= 10%. Panel (d): changes in consumer surplus, producer surplus, and export tax revenue. Panel (e): deadweight loss. Panel (f): net fiscal position (export tax revenue plus change in corporate tax receipts), which turns negative at approximately T= 4%.

To be clear, the optimal level can depend on the presumed elasticity of demand and the quantity available at each production tier. However, what is clear, is that an export tax of 25% does reduce production because it renders ‘expensive’ production technologies and exploration uneconomic.

And this is not to mention risk: commodities are notoriously volatile. Commodities companies rely on upmarkets to offset downmarkets. Remove the upside through “windfall taxes”, and the expected price received will fall. Tautologically, production will fall as higher marginal cost production is discarded.

But it gets worse. The “windfall export taxes” also send a very negative signal to successful companies: you take the risk and the government takes the rewards. Once the government sends a signal that it will impose ex post tax changes that render capex unprofitable, business will rightly scale back production. This shrinks the pie and reduces the tax base.

Myriad spurious claims about export taxes abound. The most disingenuous of which is to compare Australia to Norway. Notably, in Norway, the government controls production, owing two thirds of the major gas producer. This means that that an export tax effectively shuffles money between government departments in Norway. Norway is irrelevant to Australia. It is also worth noting that Norway has a poor record with tax design, imposing wealth and export taxes, which undermine entrepreneurship.

A related spurious claim is that exports will keep flowing even if there is an export tax and that claims otherwise are scaremongering. However, as illustrated above, it is very clear that once a production tier is uneconomic, it will simply cease. This should be accounting and finance 101: it is basic arithmetic.

The net result: export taxes are a bad idea and should be avoided. It is not clear they will even raise money and they will certainly deter production and exploration. Instead of shrinking the pie by hiking taxes, the government should look to how to grow the pie, increase the tax base, and drive growth.

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There is just one small problem: Spender’s policies are profoundly anti-worker, despite spin to the contrary.

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To see this, consider the life of a wage slave.

You work at a company to see anemic wage growth and negligible promotion prospects. You burn yourself out, but to no avail. You save a little money, but not enough. Inflation is growing faster than your after tax salary. You consider moving jobs, but industry-wide bargaining means it is simply more of the same: employers have a de facto buyers’ cartel over labor. This should be familiar to anyone who has ever worked at a large corporation.

So, how do we make life better for a wage slave? I am a wage slave. You probably are too. Would you like autonomy and hope? Or would you like to work more for a job that you don’t like for rewards that never come?

I know what I would choose: freedom and autonomy. But, how do you achieve that? Well, the answer is investing. Investing is how you “own the means of production”, to paraphrase Marx. And, this is achieved by owning assets, whether they be shares, property, or any other entity.

Allegra Spender’s tax white paper would undermine this autonomy.

She proposes a significant high in Australia’s CGT rate. This is despite the fact that Australia’s CGT rate is already one of the highest in the world, coming in at 47%. She wants to reduce the long term discount from 50% to 30%, meaning long term gains would be taxed at 32.9%, an eye watering amount. By contrast, the CGT rates in NZ, Hong Kong, Singapore, Vietnam, and the UAE are all 0%. If Australia is serious about attracting capital, it must be serious about its CGT rates.

Allegra Spender would kill negative gearing. She would ‘ring fence’ investment losses to investment gains, meaning that one could not offset income gains with investment losses. This is despite the fact that negative gearing is simply a twee term for what corporations do as standard practice: If you make a loss selling apples you can offset it against the gain you make selling oranges.

Allegra Spender would propose a minimum tax rate on investments of 27.5%. There would be no tax free threshold for investment earnings. So, if you are unemployed or retired, you are hit with the 27.5% from the start. No getting ahead for you.

Spender would dramatically high superannuation earnings. She would tax superannuation even more than the government’s proposed Division 296, imposing a 40% tax rate on balances over 3m (as opposed to the government applying that at 10m). So, if you have saved to make a life for yourself in retirement, Allegra Spender is coming for you.

And, to add insult to injury: Spender’s tax white paper dooms Australia to uncompetitiveness and poor growth. As indicated, Australia’s CGT rate is already absurdly high, being on the wrong side of the Laffer curve. But, by hiking CGT, she would deter capital from going to its best use as people will need to consider the transactions costs involve in moving assets. In turn, this would undermine growth. But, more than that, by reducing transaction volume, you reduce tax take. This is why the UK saw CGT revenue fall when it hiked CGT rates to 24% (which is notably below what Spender is proposing).

The short of it: Allegra Spender wants you to keep working longer and harder. She does not want you to achieve autonomy or independence. She wants you to be wage slave. The proposals are profoundly anti-worker and anti-freedom.

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Indeed, one might wonder how it even got to this stage. After all, one of the first lessons you should teach a child is respect. Followed by the need to own up to, and learn from, your mistakes. Parents too should become suspicious if their child seems blunder-prone, but always seems to have an excuse and a convenient patsy to blame.

This should be going through our minds when we think Jim Chalmers.

In this analogy, Jim Chalmers has our national credit card. The government is overspending, and deflecting from $15-billion lost to CFMEU related overruns and corruption in Victoria, in addition to its own runaway perk consumption. And, now Jim Chalmers wants us to pick up the tab.

Inflation has remained stubbornly high. The latest ABS inflation data puts headline inflation at 3.8% y/y. Trimmed mean inflation increased slightly to 3.4% (from 3.3%). Inflation increases the likelihood that the RBA will need to hike interest rates again. But, of course, Jim Chalmers denies that government spending influences inflation, seemingly unable to grasp the mathematical fact that government spending adds to aggregate demand, which adds to inflation.

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It seems that nothing is ever his fault. It’s always his predecessors, who were removed from office a full term ago. But, at what point, can a government stop blaming the prior guy? And, can the prior guy really be to blame for decisions that you made several years down the track.

Economists who criticize him are just partisan hacks, it seems. If he even does them the respect of getting their names right. Apparently, “Craig Oliver” of AMP, whose real name is “Shane Oliver” and told to Jim Chalmers in the very question he was answer, simply does not know what he is talking about. According, to Jim Chalmers, public spending does not drive inflation, despite it being a mechanical fact that it does. Let’s not let axions get in the way of talking points.

Former RBA governors are jilted exs who seeking revenge for the government breaking up with them. Apparently, it was simply well know that Philip Lowe wanted to be reappointed as governor; and thus, we should not take his criticism seriously.

Somewhere along the way, we let Jim Chalmers get away with spin. We taught him that spin, prevarication, and lies are acceptable. And, that they work. This is a major problem.

It is very clear that Jim Chalmers will not course correct. His failure to realize that government spending is growing unsustainably, that government spending influences inflation, and that the state is inefficient is astounding. It is the Dunning-Kruger effect writ large.

Let’s take inflation, for example. Jim Chalmers either does not know that government spending adds to aggregate demand, which tautologically influences inflation, or he is gaslighting us. Those are the two options: he is incompetent or he is lying.

Or what about the public sector. Jim Chalmers either cannot understand the blindingly obvious problem of agency conflicts, which arise where an agent is not disciplined for going ultra vires, being inefficient, or wasting money, or he is willfully ignorant. After all, when the government spends our money (not theirs), they clearly have an incentive to pork barrel and bare none of the cost of waste.

Just look at a few examples: $15 billion in CFMEU-linked waste and corruption. $2.2 million on the Green’s party room, and climbing. Chris Bowen’s $62,000 phone bill on one trip. Anika Wells spending $100,000 for her small team to travel to New York to speak for six minutes. Sarah Hanson-Young’s husband – who is a lobbyist – being flown around at the tax payer’s expense. It is very clear that big government is a wasteful government.

Or NDIS. Where to start? It is growing at more than 7% pa. This is faster than GDP growth. This alone should be a flashing red warning light. But, there seems to be little understanding that it is unsustainable for a government program to grow faster than the tax base. But, not only that, there are geographic pockets of abnormally high numbers of NDIS providers. Coincidently, once of the worst of which just so happens to be in Labor heartland in Western Sydney. Quelle Surprise.

Then there are the outright lies. Labor – and Jim Chalmers – have lied by saying they cut taxes. They did not. They reversed the stage three tax cut and made it smaller. This is a tax hike relative to the status quo. They moved to tax unrealized capital gains in superannuation and did not want to index the threshold at which it applies. Again, Jim Chalmers is lying when he says that Labor cut taxes. It simply did not. It hiked taxes and initiated plans for more hikes.

Jim Chalmers’s only solution is to try to hike taxes. Rather than acknowledging that spending is out of control, the government is looking at hiking capital gains tax. Never mind that hiking CGT is a dead weight: everyone ends up poorer. Investors, under a new regime, will find it optimal to hold assets rather than sell. But, the first best would have been able to see, but that option is now prohibitively expensive. But, in so doing, the government actually foregoes revenue, because transactions reduce. The state governments then bear a cost due to falling stamp duty. The idea of hiking CGT is a basic failure to understand cause-and-effect.

So, what can we do about a treasurer that always finds someone else to blame? Well, metaphorically, hold his feet to the fire. The Liberals must hang him by his own petard with his own terrible record of high inflation, inexorably increasing government spending, and wasteful attempts to increase tax.

Most importantly, we must never agree to any tax hike all the time the government covers for, and funds, rampant corruption: we, the tax payer, should not be paying the price for government ineptitude and rent seeking.

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The high spending – and reticence to cut it – has led the government to look for more ways to raise money.

The Senate is investigating whether to hike capital gains tax by reducing or eliminating the long-term capital gains tax discount. The government has been coy about this, seemingly flying a kite to see how people react. At present, the focus appears to be on how the CGT discount applies to housing.

Proponents of higher CGT have claimed that it will help first home buyers by ‘forcing’ investors to sell or driving investors from the market. However, the proponents of higher CGT are wrong.

Hiking CGT will backfire and will not help with the housing crisis.

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Construction

Higher CGT will deter construction. This is very clear because investors – especially developers – are rational value maximizers. They care about the after tax returns on an investment. If the returns are below that of listed investors, they will pivot their resources. Thus, if the already low returns to property development are reduced even further, fewer developments will occur. At a time when we are struggling to build enough houses, higher CGT will make the supply problem worse not better.

What if we just allow the discount for new builds, and remove it for existing stock? That will make the hike marginally less bad. But it will not solve the problem this is because developers need to sell stock. Buyers will clearly consider the CGT that applies to them. So, the buyer will factor that into the price they are willing to pay. Now, some might think that this would reduce house prices. For a very short period, it might. But, developers will see the lower profits, shelve marginal construction, and supply will shift down. So, no, only allowing the hike for new builds will not solve the problem.

Housing stock

Hiking CGT will also reduce the amount of stock available for sale. This is a problem as it means that people will need to rent for longer. The reason this will happen is that people will lose up to half their equity as soon as they sell.

Let’s put some numbers on this. Suppose you buy a property for $100. It increases at the rate of inflation (say 3%) for 10 years and it is now worth $134. This is a terrible return as the a levered investment in the S&P500 would achieve significant more. But, suppose the investor has that $34 in equity now. If they sell, the equity falls to $18 if they are on the highest marginal tax rate. That is, their equity nearly halves. It is obvious that an investor would not sell as they will see their gains erased. The highest the CGT rate the fewer sales will occur.

The net result is that there will be less housing stock available to buy. This might force people to rent for longer. It could also (ironically) support house prices due to supply ratcheting down. Or phrased differently, the price at which an investor is willing to sell is now higher than it would otherwise have been.

Revenue

What then about revenue? Hiking CGT rates is sometimes seen as a revenue raising exercise. If we ignore cause-and-effect, the logic looks superficially clear: higher tax rates mean higher revenue, right? Wrong. Because hiking CGT will, as indicated above, reduce transaction volumes. Lower transaction volumes mean less capital gains tax intake and less stamp duty.

To put this in context, the UK hiked capital gains tax rates to 24%. Notably, this is below Australia’s capital gains tax rates currently. Capital gains tax revenue then ell by 10%. This was due to a combination of people leaving and fewer transactions.

To use another example: California was considering a ballot initiative to impose a one-off 5% wealth tax. As a result, $1 trillion in wealth left California before the initiative was even decided on and despite resistance from Governor Newsom. The result is less revenue and less money reinvested in the economy.

Where does it leave us

The overall result is that hiking CGT rates is not a solution to the housing crisis. It risks making the situation worse and reducing government revenue. The spin around hiking CGT rates does not stand up to scrutiny.

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The simple fact is that government spending is a key inflation driver. It is not the only driver. Jim Chalmers insinuated that it is not a driver at all. Is he correct, or is it just spin?

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Let’s start with the obvious. Jim Chalmers suggested that because the RBA had not called out government spending, the RBA therefore thought that government spending was not an issue. However, Jim Chalmers fundamentally misunderstands the RBA. The RBA is reticent to explicitly call out government spending. The reason is obvious: the RBA does not want to be seen as partisan or wade into politics lest it jeopardize the RBA’s perceived independence.

Government spending has consistently increased since Anthony Albanese assumed office in 2022. Of course, inflation can partly explain the increase. However, this is chicken-and-egg. The decision to keep spending at the newer higher prices just ensures that demand continues and stops inflation self-correcting. That is, when consumers are price-sensitive, the cure for high inflation can be inflation itself as high inflation damps demand, which helps prices to normalize. Self-correcting mechanisms are often insufficient to correct inflation, hence why central banks also use interest rates to force such a correction. But, if the consumer – here the government – keeps spending that self-correcting mechanism does not work.

The short of it is that government spending supports demand, which supports inflation. Now, one might wonder how government spending influences housing prices. Or recreation. Or transport. Well, when the government spends money, it buys raw material inputs and labor. These are the same inputs that would go into housing construction, inter alia. Thus, input prices increase across the board, which then drives inflation in myriad areas.

But it gets worse.

Government spending is inherently less efficient and productive – and thus more inflationary – than private sector spending. There is an adage that when you spend your own money on yourself, you care about cost and quality, but when you spend someone else’s money on someone else, you care about neither cost nor quality. Thus, when a politician spends tax payers’ money to build a tunnel for someone else, they have less incentive to be efficient. And indeed, their incentive is to build something to generate votes even if the economics stack up.

The problem is agency conflicts. Agency conflicts arise whenever you hire someone to perform a job. Here, the agent (i.e., employee) might have an incentive to shirk, waste resources, or grow the department inefficiently so as to look more prestigious.

Agency conflicts, and the associated waste, are especially bad in the public sector. There are several ways to combat agency conflicts. First, you could discipline workers (or executives). In the private sector, this can involve monitoring, and firing. This is especially the case for more senior executives. Second, incentive contracts can drive better performance. But, government departments are notorious for poor incentives, stagnant wages, and a lack of bonuses. Thus, as a worker becomes more experienced, the main way to get a “raise” is to work less hard or direct resources in ways that implicitly benefit the worker. Thus, when 80% of new jobs are in the non-market sector, you get more inefficiency.

Examples abound. Let’s take the Machete Bins in Victoria. The machete bin program cost some $13 million, involving a massive advertising and education program, and the installation of 45 bins to collect machetes. That’s a staggering cost. Each bin might have cost a few thousand to construct, but the all-in cost amounted to some $300,000 per bin. But not only that, the policy is absurd: machetes can easily enter Victoria via its land-borders, it is very clear that criminals would not deposit their machetes, and it is obvious people could just replace a machete with a meat cleaver if they wanted to do crime. The short of it is that the government spent tax payers’ money, and did so inefficiently, in order to be seen to do something. Jacinta Allan spent our money, pursuing a nonsense policy, to try to get votes. This is the problem with government spending.

Then there is the NDIS. It is growing at more than 7% pa. This is simply unsustainable because it is growing faster than the economy. Notably, there are some very curious clusters of NDIS providers in different regions. A curious mind might wonder precisely why, whether demographics explain the clustering, and whether there is wastage or largese. The raw NDIS provider data is available here, and to premium subscribers to download (see end of article).

The inefficiency can be unfortunately self-perpetuating. An ambitious bureaucrat might well want to be promoted or earn more money. How do you achieve that, by running a larger team with a higher budget? So, what do you do, you create projects to justify a higher had count and greater expenditure, thereby making yourself look more important. It certainly happens in the private sector. But economic reality has a way of catching up with executives who burn shareholders’ cash. By contrast, the public sector solution is to try to find more money.

Jim Chalmers is looking to make this worse. Division 296 looms on the horizon. It is a tax hike to enable the government to spend (or waste) more money. Similarly with the capital gains tax review. But, the problem (inter alia) is that this just soaks up money from a productive user to an inefficient one. And, let’s not forget bracket creep.

The net result is that government spending both increases demand and that increase is inefficient relative to keeping the money in the private sector. Indeed, if Australia is serious about driving productivity, the government must stop hoovering up revenue, only to spend it inefficiently, and must seriously look to cut income, corporate, and capital taxes, which will drive expenditure to its most productive home.

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Note: For those of you who would like to expore the weirdness of NDIS/social service distributions, you can check out the data if you are a premium subscriber (see below).

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So, is a wealth tax a good idea? The short answer is no. It is a very bad idea and will cost Australia in the long run.

Let’s look at recent precedent. California has mooted introducing a wealth tax. This would come in a union-backed ballot proposal that would go to the vote in November. The current proposal is a one-off 5% impost. California Governor, Gavin Newsom, who is hardly a conservative, has objected to the proposal.

What happened in California? Well, the wealth tax has not even passed and billionaires are moving. Reportedly, up to $1 trillion in wealth has left the state. And this before the proposal even became law.

So what exactly happened?

Think of it this way. Suppose you want to paint your house. The going rate is $5,000. But, you only offer $3,000. The painter will take his/her labor and go elsewhere. This is the incentive compatibility constraint in action: you must at least beat the next best offer to keep the painter.

The analogy applies equally to capital. Suppose someone has assets. They can choose to live in California. Perhaps they like the weather or their family is there. So, they would prefer to stay. But, Texas, Florida, and Wyoming offer better deals. The weather is not quite as nice, but they have no state taxes and certainly no wealth tax. After a point, the cost of California’s taxes gets so high that people move. Again, it is the incentive compatibility constraint: if you want capital in your location, you must compete with the next best after tax return.

These departures have major financial impacts: This comes from income tax foregone, reduced capital availability and growth, reduced business formation, and lower job creation.

In Australia, the top 1% of all tax payers account for nearly 20% of all tax revenue. The top 10% of tax payers account for around 46% of all tax revenue. If you lose your wealthy people, you lose your tax revenue. This goes doubly if those people ran corporations. After the person moves, they will logically be more likely to create jobs in their new domicile. This is partly out of geographic salience and partly out of caution about their old home.

And, so we can see precisely what would happen in Australia.

The wealthier a person, the more mobile they are. Their income does not depend on them being in a specific location and seeing specific clients in person. Furthermore, while many ‘wealthy’ people rely on property for their wealth, the wealthier a person is, the more diversified they usually are. Some might say “good riddance”. But, then, one would also say “good riddance” to your tax revenue.

If Australia introduces such a wealth tax, people will weigh whether Australia’s weather really is good enough to justify the higher government charges. Or, perhaps they could just move three hours away to Auckland, which has no capital gains tax, let alone a wealth tax. Same with Hong Kong, Singapore and the UAE.

But, couldn’t Australia then just make the tax a one off? Well, this is the approach in California, and people are still moving to greener pastures. But, let’s face it, once the precedent is set, no one will believe that the tax is a simple one off.

How about imposing an exit tax or stopping people from leaving? Australia could try this. Of course, a reasonable prediction is that people would leave before the exit tax commences. This is because an exit tax is more pernicious than a wealth tax. So, if a wealth tax precipitates departures, so would an exit tax. But, worse, it would deter people from moving to Australia. This would then deprive Australia of capital, which would harm growth and tax.

The discussion in relation to wealth taxes exposes an inherent problem with Australia’s political discourse. It has become fashionable to play up “principal-principal”. High net worth individuals already pay the lion’s share of tax revenue. As indicated, the top 10% of tax payers accounted for around 46% of tax revenue. But, voting rights do not correlate with tax paid. This creates a myopic incentive to expropriate wealth.

A wealth tax will trigger human and financial capital to leave. It’s not the 1900s anymore. Thereafter, growth will fall due to reduced capital availability and the departure of precisely the type of business-creators you would want to retain. And, with lower growth you get less tax revenue, less productivity, and fewer jobs. At a time when we need to grow the tax base, a wealth tax would shrink it.

The government would be better served trying to grow the economic pie rather than trying to seize a larger slice of a pie, which it then causes to shrink.

So it is with business management: Imagine your business is going under. You’re getting smashed on both revenues and expenses. Do you hire a cheap CEO to save money, and risk that CEO being cheap for a reason? Do you appoint your top engineer – who might be very good at his or her job – but who has no background in finance or accounting? Or, do you search for a skilled CEO and pay the market rate? What do you do?

Now consider a situation where you really want a turnaround specialist. It requires deep expertise, and involves a lot of work and long hours. The specialist will make a lot of enemies. But, you’ll only pay him/her very similar to the other employees. How many people will take the job and deal with the stress? Maybe they would prefer to not deal with it? Or, if they want to take on such a role, they will look for a different employer?

These analogies have strong parallels to university management and how we pay university CEOs, or Vice Chancellors (VCs).

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University governance is under scrutiny. This is why the Department of Education has moved to improve how universities are run, recently releasing a report on governance principles. There are many concerns, ranging from a bloated internal bureaucracy, through to rampant violations of labour laws, and a perceived lack of accountability. But, here, I will focus on one of the most contentious: remuneration.

Universities are in a bad financial state. Revenues are under pressure owing to restrictions on international students. Talk of restructuring exacerbates this, as students become wary of joining a university whose rankings might fall. Conversely, expenses are also increasing. Student demands are also increasing, partly owing to a situation of over promising, and potentially under delivering.

One of the proposed remedies is to cap vice chancellor pay. Various caps have been proposed, but all caps are below current salaries. It’s straight out of the Fabian Socialist playbook, designed to destroy ambition and aspiration.

Capping VC pay, unfortunately, will lead to significant unintended consequences, which risk exacerbating the death spiral in which universities already operate.

It’s a case of proposing the wrong solution solve the identified problems. Of throwing the baby out with the bath water. Of amputating a leg to solve a sprained ankle.

Let’s start with what a VC does: A VC position is not an academic position. Vice Chancellors are CEOs. They oversee large, complex, organizations with thousands of employees and tens of thousands of “customers”. Few academics have the experience or skills required to be a VC. As skilled as a professor might be at his/her research, research is not the same as running an organization. To run an organization, you might have real world, evidenced, business skills.

The immediate, and direct, impact of crunching VC pay therefore is that you will not be able to hire anyone competent. We might debate whether VCs are currently competent. I will address that shortly

It is undeniable that if you cap VC pay, many people will not take the job. Why is this the case? Well, it is because well over 200 US universities pay VCs more than AUD 1 million, while offering more perks and lower tax. It is a no-brainer that a qualified VC would take a US position if VC salaries are cut.

Another comparison is pay in the private sector. Again, VCs manage large, complex, organizations. People with those skills can work at listed companies. Corporate CEOs earn significantly more than do VCs. If pay is cut, it is easy to see that a qualified person will simply move to where they can earn more for their skillset. Some might stay in the academic sector out of ‘intrinsic motivation’. But, intrinsic motivation does not buy nice things. Clearly, some VCs could not get a corporate CEO job. But, do you want to be stuck with the people who cannot get a corporate job? Or, do you want to be able to access a broad pool of talent?

Sometimes people remark that universities are ‘different’ from the private sector so should pay differently. But, that only works if the demands and job are different. If the job description is akin to that of a private sector CEO, and those are the skills you want, then that is the benchmark you must use.

Politician pay is a false comparison. No CEO benchmarks their pay to that of politicians. Indeed, the low pay, terrible conditions, and poor career prospects likely deter many talented individuals from entering politics. That is, politics already evidences the problem of a worsening talent pool.

People might argue that VCs already do a bad job. Thus, they are not worth their pay. In some cases, that might well be correct. However, the solution is to improve hiring practices and select competent people, not narrow the pool of potential candidates and only be stuck with underqualified candidates.

The indirect consequences of crunching VC pay are also important. You will face significant staffing problems. This is due to pay compression. If you cut VC pay, then deputy VC pay must also fall. And, Dean-level pay will fall. After all, why be a VC if being a dean pays better? But, then academic pay must also fall. Again, why take on the responsibility of being a Dean if you can just be an academic?

The problem is immediate: how do you incentivize people when you crunch pay and there is no clear increase through hard work, or ambition? In short, crunching VC pay is a recipe for tenured faculty ‘quiet quitting’, if they have not already. It will also make it nigh impossible to hire talented academics in the international market: why come to Australia to earn less and pay more tax? This is important as the academic labor market is international.

There is also an implicit problem: how do you keep industry- engaged and public-facing academics when you crunch pay? They have outside options in industry. Universities, and academics, have usually sneered at these. But, the inescapable truth is that if you don’t match industry pay, adjusted for conditions, you will lose people. And, the people you lose will be the most practically focused. That is, they will – ironically – be the people that the public say they would most like to keep.

The net result: crunching VC pay has significant unintended consequences and it will backfire. It will exacerbate the death spiral in which universities currently find themselves.

Universities must – however – improve their executive hiring practices. And, long term, they could consider incorporating so that they can offer ESOPs and pay VCs with equity. This, however, might be a bridge too far given the anti-aspiration rhetoric that often surrounds the education sector.

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Suppose you hire a painter to slather your Victorian-era house in bright red paint, with purple accents. The painter’s brow furrows as they warn you that such colors are rarely a good look. But, you proceed: you just want a red house and you’re sure Vogue said that purple is in this season. Your painter proceeds with love and care while your neighbours…

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A university is not an easy business to run. But, a business is what a university is. Competing demands, some logical, but many not, tug at the purse strings. People expect you to have a magic pudding of money.

Budgets can change on a whim, with little warning and no recourse. Vice Chancellors are perhaps uniquely positioned among academics to know the dangers of the piles of regulation for which many academics seem to extoll.

Running a university takes a significant amount of business acumen. And this is precisely the problem. Many Vice Chancellors simply do not have the business skills necessary to run a large, complex organization. Some also appear to be willfully ignorant of precisely what happens in their own organizations.

Some Vice Chancellors are cosplaying as CEOs, as it was pithily put on reddit. I am fortunate to work at one of the better run universities. However, I feel for many academics that are stuck elsewhere.

So where did things go wrong? Well, it’s the old axiom: ‘show me the incentives and I’ll show you the outcome’. Interestingly, two academics: Bengt Holmstrom and Paul Milgrom formalized this in their seminal work in the 80s and 90s. They both subsequently won separate Nobel prizes.

In short, if you want to ‘grow the pie’ you might incentivize people to grow it. If you take the approach that there is a ‘fixed pie’ that you must allocate, your pie will actually shrink as people leave to a place that will reward them. Or, if they stay, they exert less effort than is optimal. It underscores the logic behind the Laffer curve. It also explains why the UK’s move to hike capital gains tax actually resulted in a fall in capital gains tax receipts: people left.

The problem is that incentives in universities are haywire.

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Universities are run like a socialist dystopia, in many cases. Despite many academics being left leaning, their complaints about universities show precisely why the ideology that many lionize is so catastrophic.

If we look at individual academics, there is little – if any – incentive to work harder or produce more outputs. Pay simply flatlines. In many fields, there is simply no ‘supplementation’ or ‘loading’ or ‘bonus’ for doing a good job. A professor with 20 years experience might well be paid the same as one with 1 year of experience.

Similarly, if you establish a lab, create a new course, or establish a new program, there is no upside. The bonuses are nigh nonexistent. And, academics do not own shares in the company.

The only way to get a ‘seniority’ bump in your salary is to use your expertise to be more efficient and work fewer hours. You can immediately see the problem: your skilled workers are incentivized to quiet quit rather than work more hours. Ironically, this is exactly the opposite of what you would want to achieve.

Academics who want to work more hours and to get ahead might well be better served going to industry or doing a side-hustle. Or going to the Middle East to earn more money and pay less tax. Ironically, given the emphasis on universities needing practical, real world insights, they risk losing precisely the type of people that the general public wants them to keep.

This also has other unintended consequences. Academics – starved of pay increases – look to get ‘utility’ from nonpecuniary avenues. These can include ideological posturing. They might think ‘if I’m not going to get paid more, I might as well gain by using my soapbox’.

Vice Chancellors also face incentive challenges. Vice Chancellors’ bonuses are small. They are underpaid relative to US university presidents or CEOs of other large organizations. Indeed, against what metrics do you even judge a bonus? In the private sector, we would base it on profit maximization and share price. But, in the arcane world of nonprofits, where government can slice revenues on a whim, it is not so simple.

The bureaucratic – public sector – mindset exacerbates things. Vice Chancellors are implicitly incentivized to not run a surplus. This is because if they run a surplus all manner of demands for value-destroying projects will accrue. These will be unsustainable if the surplus dips. Thus, pragmatically, Vice Chancellors cannot easily run a surplus to save for a rainy day. Ironically, if they were to do so, politicians might well point to those savings as a reason to cut budgets. The irony is a very odd incentivize to not be fiscally responsible today because to be responsible is to risk irresponsible consequences tomorrow.

Then there is the bureaucratic blob. Academics hate admin. But, then seem to also decry the number of professional staff. Universities cannot function without them and they are invaluable. Especially given the sheer weight of the regulatory burden. But, let’s face it, there are groups that add no financial value. And, when your own pay turns on managing a bigger team to get higher seniority, you are incentivized to grow your team whether or not it makes financial sense.

How then do we fix this?

Well, there seems to be little appetite to do so. We need to acknowledge that universities are businesses and that they should be well run. At present, they appear akin to state owned enterprises and appear to suffer similar flaws , which, ironically, business academics have well documented.

Academics – to their own great detriment – seem to disdain market solutions. But, in an ideal world, perhaps universities should incorporate. Faculty could buy shares (and be paid in shares), and incentives could be (more) aligned. After all, if an academic owns enough shares, they might well want fiscal discipline. But, alas, such an elegant solution appears to be a nonstarter.

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But, despite the shemozzle that is the roundtable, Australia has very real problems.

Australia has a budget problem. It is spending more than it is raising. The government is scrambling for money and talks of “tax reform” have gathered steam. To this end, parliament recently hosted a “tax roundtable”, in which “experts” proposed that CGT be raised and additional taxes imposed on trusts. The ACTU has now called to hike CGT as well.

There are many proposals to unpackage. But, let’s focus on the CGT one: CGT is most frequently misrepresented, often by people who do not invest and have little engagement with financial markets.

There’s just a tiny problem: Australia has literally the highest CGT rate in the world. Australia’s top CGT rate is currently 47.5%, the top marginal tax rate. Many people obtain a 50% capital gains tax discount for holding the asset for more than a year. But, even at 23.75%, Australia’s rate far exceeds other countries.

Let’s see how this compares: New Zealand has 0% CGT. But, it’s not just New Zealand. Singapore, Hong Kong and the UAE have 0% CGT rates. Communist run Vietnam and China have 20% CGT rates. In the US, capital gains are taxed at the personal rate, with a 50% discount for long term gains. The tax rates in the US are lower than in Australia and are indexed.

There are simply no other countries near Australia’s current CGT rate. The idea of hiking CGT rates is – to put it bluntly – absurd and insane.

This also illustrates a broader problem with roundtables: the host can select participants to support a foregone conclusion, enabling ideologues to masquerade as “experts” and shutting out contrary opinions.

In this case: the alleged “experts” appear to support a policy that will backfire. Not only that, there is very recent precedent in the UK to evidence precisely this. So, let’s dig deeper into the issues with hiking CGT.

The short of it is that Australia’s CGT rates are already among the highest in the world. Raising CGT rates will result in less tax revenue and stymie growth. This is due to how CGT rates influence investor behavior. Proposals to raise CGT are myopic and ignore the incentive effects of raising CGT. They also ignore that Australia is in a global competition to attract, and retain, capital.

Let’s start with recent precedent: the UK tried this and it failed spectacularly, resulting in less tax revenue as people fled the country. In short, the UK sought to increase CGT to around 20-24% and tax offshore income. Notably, this is still lower than Australia’s maximum CGT rate of 47.5% for short term gains to someone on the highest marginal rate.

The net result of hiking capital gains tax rates in the UK: human and financial capital left the UK. The UK is estimated to have lost at least 16,500 millionaires and capital gains tax receipts fell by 10%.

So why is this the case? Well, it’s Economics 101 and has been known at least as far back as Holmstrom and Milgrom’s seminal 1987 paper. Both Bengt Holmstrom and Paul Milgrom went on to win separate Nobel prizes. Their paper models the situation where a company’s value depends on the ‘effort’ of its employees. They highlight that incentive compensation contracts induce effort, enabling both the company and the employee to grow wealthy together. They also emphasize that the employee will only work if the incentive contract pays them at least a ‘reservation wage’, which is at least as good as their outside opportunities (i.e., other jobs), and compensates them for the effort they make.

There are clear insights for CGT. Australia’s GDP grows with investment. But, it will only get investment if investors feel the after tax returns to them are sufficient. And, when considering this, they will consider whether it is worth moving overseas, which is significantly easier than it once was.

Australia must be extremely careful about increasing CGT lest it deter investment, and lead to capital flight. Let’s illustrate several key issues.

Australia must have regard to CGT in other countries. Australia must not be complacent or arrogant and think that it is entitled to, or guaranteed, capital investment. Human and financial capital is more mobile than ever. This is a significant issue for Australia as its CGT rates are among the highest in the world. Notably, myriad locations have 0% CGT. These include Singapore, Hong Kong, and the UAE. More importantly, they include New Zealand, which is but a short flight away. In short, Australia risks significant capital flight to New Zealand. Australia is already unable to attract significant capital.

Australia still has some capital activity. This is because on an after-tax basis there are still some good opportunities and there are inherent frictions in moving overseas. However, Australia is doing worse than it would otherwise do.

Australia could counter this trend by cutting CGT. In so doing, it can attract more capital relative to its already high CGT rates. Furthermore, it can stem the flow of capital overseas.

But lowering CGT gets better! Lower CGT means more transaction volume and transaction frequency. At present, people wait one year and a day to get the long term capital gains tax discount. But, this grinds transaction frequency slower, in turn reducing total tax revenue. Instead, consider a situation where all CGT were 15%. Well, it only takes two transactions to raise more revenue than the current long term rate of 23.75% for the top marginal tax payer.

Raising CGT will slow transactions, reduce transaction volume, and reduce total revenue. Think of it this way. The current long term CGT discount is 50%. A proposal is to reduce that to 30%, or eliminate it entirely. So, consider a situation where someone bought a house for $1m, and is considering selling it for $1.5m, perhaps for another investment opportunity. Currently, they would pay approx. $120k in tax if they are on the top marginal tax rate. This reduces their equity from $500k to $380k, which falls again if they must pay stamp duty on the next investment. By contrast, if the long term discount falls to 30%, their equity falls to around $333k. If the long term discount is eliminated, the equity falls to $263k. The net result is that the next transaction must be even more attractive for it to be worth selling, resulting in fewer transactions; and thus, less revenue.

And this is to say nothing of the impact on economic growth. If, as indicated, capital leaves Australia (or fails to come to Australia), it is easy to see how this will impact growth. This is financial economics 101. If there is less capital available, then capital rationing will occur. Projects that might otherwise have been good will simply not be funded. The result: less economic growth, and with it, less tax revenue.

Where does this leave us: hiking CGT rates is self-defeating. It risks reducing overall tax revenue and overall economic growth. Any talk of tax reform must consider incentive effects and must consider how Australia with other countries. It must also take a “pie growing” mindset, with the goal of increasing the economic pie rather than merely carving up a stagnant one.

Unfortunately, Labor’s plan to tax unrealized capital gains will take a sledgehammer to a sector that is vital to Australia’s productivity and growth. This is unfortunate: Growing the economy – and the tax base – is precisely how the government can afford to pay for nice things.

Initially, Labor’s tax on unrealized gains would apply ‘only’ to 0.5% of superannuants as it ‘only’ applies to people with balances above AUD 3 million. Leaving aside the moral repugnance of targeting someone merely because they are wealthy, the number of people impacted will expand. This is because the aforementioned $3 million threshold is not indexed and Labor’s budget is banking on bracket creep. The intention is to not raise the threshold so as to capture more people.

This will harm startup investment.

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Superannuation funds heavily back startups. To put this in perspective, Australia Super purports to invest 5% of its portfolio in private equity, and had previously aimed to increase that allocation to 8%. This amounts to at least $15 billion in unlisted investments. Aware Super claims to have invested $9 billion in private equity, with at least 25% being in growth or venture-style investments. Thus, many superannuants are exposed to unlisted assets, and startups, without even realizing it.

Self managed super funds (SMSFs) also invest in startups, often directly in companies. SMSFs also often have more concentrated portfolios than do standard super funds. At least 20% of startup funding comes via SMSFs; some reports estimate that the figure could be as high as 60% of all startup funding.

Superannuation is a nigh essential model for startup funding. This is because the risks of investing in startups are extremely high. Thus, for the after tax payoff to be sufficient to take that risk, the tax rate can be no higher than the superannuation rate. If the tax rate more than doubles – as would be the case outside of superannuation – then many startups would simply not offer a high enough potential return to attract investment.

The tax on unrealized capital gains, in addition to the tax hike to 30%, would undermine superannuation funds’ investments in startups. Let’s not forget that the long term capital gains tax rate is below 30%. That alone would be bad enough. But, taxing unrealized gains takes it to another level.

The tax on unrealized capital gains creates significant risks for superannuation funds. This is because if an unlisted company hypothetically increases in value, then superannuants will be liable for the tax on such gains. But, since the assets are unlisted, they cannot be sold to pay the tax. This creates a liquidity risk.

The money to pay the tax must come from other assets, presumably forcing an asset sale elsewhere within the fund. This creates major issues for asset allocation: how do you plan long term investments when you do not know what you might need to liquidate to pay an unknowable tax? Presumably, the portfolio would become increasingly concentrated in unlisted assets, as the listed ones must be sold to pay the tax. But, this just amplifies the risk of future imposts.

The tax on unrealized gains can thus create a death spiral where the only assets left in the portfolio are unlisted as all listed ones have been sold to pay tax. It is difficult-to-impossible to sell shares in unlisted companies. This begs the question of what then happens when there are no liquid assets left to sell?

The problems are amplified when we consider that startups can soar in value only to fall into bankruptcy. In this case, the individual must pay taxes on the unrealized gains. But, when the investment falls, they only receive a tax credit to offset against future losses. They do not receive a refund.

This problem with only receiving a credit for future gains is obvious. A dollar today is worth more than a dollar tomorrow. Thus, due to inflation, the value of that tax credit diminishes over time. But, the person must pay the tax on unrealized gains immediately. Furthermore, it is quite foreseeable that if the superannuation fund invested in a ‘paper unicorn’, which subsequently failed, the fund might never make enough money to use that tax credit.

These concerns do not merely apply to superannuants with balances above $3 million. This is for the very obvious reason that the $3 million is not indexed with broader market returns. At an average return of 10% pa, $3 million is equivalent to $450k in 20 years time and $66k in 40 years time. It is myopic in the extreme to focus on the $3 million threshold and to naively hope that it is appropriately raised when the government has signaled ever intention to not do so.

The net result: superannuation funds, especially SMSFs, will not invest in startups. The corollary is that the innovation Australia sorely needs to improve productivity will suffer even more capital rationing. This is not to mention the terrible precedent the tax sets: investors will rightly fear that the tax will expand. Once that fear sets in, Australia will be uninvestable.

If the government is serious about innovation and productivity, it will dump the tax on unrealized gains.

Division 296 would impose a tax on unrealized gains earned on superannuation balances above $3 million. This threshold is not indexed or benchmarked to the market. The tax rate would be 30%. For these reasons, the tax hike especially impacts younger Australians.

Jim Chalmers has spun this as a small tax that would only impact very wealthy Australians. However, when you actually dig into the mechanics, it is designed to impact all Australians, is retroactive in effect, and sets a dangerous precedent. So much so, that it will hike taxes by $7 billion every single year in a decade.

People are finally waking up, thanks in no small part to Geoff Wilson, of Wilson Asset Management, who has been leading the campaign against the tax grab. So, let’s explore why it is so controversial and why it is so harmful for younger Australians.

The problems with Division 296 and the tax on unrealized capital gains

It will impact everyone, not just the wealthy: The most obvious issue is that this imposes yet MORE Bracket Creep: Division 296 is designed to catch all Australians! The weasel words about it only impacting the big end of town are duplicitous and misleading.

Let’s look at the $3 million threshold. Jim Chalmers bills this as only impacting a small number of Australians. This is absurd. Suppose an 18 year old will retire in 50 years. Then, by the time he/she retires, then at an inflation rate of 2.5%, $3 million now is equivalent to only $875k then. But, it gets worse. Suppose the investment return is 10% pa, based on a portfolio of both ASX200 and S&P500 stocks. Then, that $3 million is equivalent to only $25k.

What about illiquid assets: It is not uncommon for large superannuation balances to be concentrated in illiquid assets, such as [farm] land, or unlisted companies. For example, suppose an investor has devoted part of their portfolio to early stage startups. Now suppose one of them were Canva. Canva is not listed. An investor in Canva cannot easily liquidate their holdings. But, under Div 296, the unrealized gains on Canva would be deemed to be ‘earnings’ and taxed at 30%. How then is this supposed to be paid?

The net result is to discourage the use of superannuation to invest in venture capital, including in venture capital funds. This starves Australia’s already struggling venture ecosystem of capital.

Reduced faith in the super system and in government: Investors devoted money to superannuation funds based on the rules that existed. However, Division 296 is a retroactive tax. It applies to existing investments, imposing an additional tax on money that people locked into superannuation on the representation that the tax rate was a certain amount. Division 296 – via its tax on unrealized capital gains – effectively becomes a mechanism to expropriate the assets that people have stored in superannuation. The net result is a reduced trust in the superannuation system and other government-linked financial scheme.

Bad precedent: Extremely troubling precedent involving a tax on unrealized capital gains. Once the precedent is set, this can clearly expand either outside of super or into all super balances. This is not a far fetched fear because the rhetoric surrounding Division 296 has no limiting principle. Rather, the rhetoric is ‘some people have a lot of money, let’s increase taxes on them’. Why would one believe that the government would not subsequently salami slice the policy into other areas once the precedent is set.

When we add this together, we see that Div 296 is inherently ‘unfair’, sets a bad precedent, and should be junked. The rhetoric surrounding high income earners is intellectually dishonest: The top 1% pay around 20% of all taxes (According to the AFR). If we are talking about "paying their fair share", the impacted people already have.

What we should do instead

Let’s consider an alternative. How can we have a win-win: let people keep more of their money while also raising more revenue?

The clear solution is a recalibration of capital gains tax for all investments, not just superannuation. Set short term CGT at 20% and long term CGT at 15%, hypothetically. The lower the better. Apply this to earnings (not gains) on superannuation balances. Apply the higher rate to any investment made after the rule-change. Apply the prior rate to any investment made before the rule-change. This new CGT rate must apply to all investments otherwise it simply becomes a tax hike. CGT must be untehtered from income tax.

Why would this work:

1. It would encourage more transactions. Instead of people waiting a year and a day to get the long term capital gains tax discount on stocks and other investments, they could transact whenever they choose. The incentive to wait one year would be lower. This would ramp up trading volume, thereby raising revenue. It would also enable people who put in the work, or take the risk, to keep more of their own money.

2. The slight increase in CGT on superannuation funds would also raise more revenue. Notably, this would not be a retroactive tax or a tax on unrealized gains. It would only apply to actual realized gains or earnings. The new rate would only apply to new investments and not to previous investments.

3. It would deter capital flight to the United States. Australia needs more investment. Australia needs more growth. This growth can help to pay for government spending programs. But, the growth slows whenever government starts taking a larger slice of it to fund out of control spending.

This proposal would enable the government to both raise more revenue and enable people to keep more of their own money. This is a win-win.

Let’s also be clear: any treasury modeling of this must account for both the increased trading and transactions that would raise from lower CGT and the incentive effects from the lower CGT. Modeling that fails to account for these upsides is simply misleading and erroneous.

Jim Chalmers could be the treasurer that delivers genuine growth, and tax cuts, and more revenue. However, one fears that Jim Chalmers believes that if your policy is to rob Peter to pay Paul, you can always count on the vote of Paul. Hopefully, Jim Chalmers recalibrates and ushers in an era of optimism.

Fast forward to the present and it appears that governments still have not learned and seem not to realize that usurious taxes can backfire and do so for multiple reasons. Case in point is tobacco taxes. Australia provides a cautionary example.

Australia has imposed extremely high tobacco taxes for many years now. The tobacco excise has increased by 282% since 2013. Wages have increased only 31% over that time period. At present, a 25-pack might cost around $50, with $34 going to the government. The tobacco excise is over half the cost of the product. Furthermore, treasurer Jim Chalmers vowed to increase the excise by another 5 percent, on top of the normal indexation, for three years.

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Despite an increasing tax rate, tobacco excise revenue has hit a 9-year low. This is telling. Tax rates are increasing, but the total tax take is falling.

The stated rationale for the high tax rate is that high prices will force people to quit. This is based on the idea that smokers develop cancer; and thus, the tobacco excise pays for the cost of treatment. Furthermore, the government has deemed it worthwhile to encourage people to quit in order to improve their health. Certainly, it is likely that the taxes have contributed to a fall in smoking uptake.

Ironically, the government’s stated rationale is reminiscent of the Laffer curve. The higher the tax rate, the less likely a person is to work harder or risk their capital as the marginal cost of doing so, in terms of time, effort or risk, is higher than the after tax marginal benefit.

Nevertheless, given that we know the history of prohibition, we know that tobacco sales might simply have gone underground. The question is then: if tobacco tax rates are increasing, why has tobacco tax revenue decreased? There are two possible explanations:

1. High tobacco taxes has encouraged people to quit

2. People are buying ‘black market’ tobacco

Well, certainly some people have quit. But, The Australian Financial Review notes that “The Tax Office estimates a record 18 per cent of all tobacco for sale in 2022-23 was illicit, and would have earned the federal government an extra $2.7 billion if it was instead sold legally.”

There has also been a reported surge in crime related to illegal tobacco. This includes reports that criminals have firebombed retailers that have not complied with their demands. This appears to be an especial problem in Victoria, one of Australia’s most “progressive” states.

The result is clear: The high profile firebombings are anecdata. But, coupled with the alleged increase in illegal tobacco sales, it appears that taxes have forced at least some people to buy illicit tobacco. The question is then how to respond.

The major political parties have vowed to increase enforcement. The opposition has vowed to spend $250 million to increase enforcement. The opposition treasurer stated “It is clear that we need a tough cop on the beat to respond to the lack of real action from the Albanese government, which has allowed the illicit vaping and tobacco black market to thrive,”

The alternative is to reduce taxes to reduce the incentive to buy illicit tobacco and the incentive to supply it.

The path that the government has taken is no surprise. But, it’s also a recipe to make everyone’s life worse. In essence, the government becomes addicted to a revenue stream. It starts spending that stream, with recurring expenditures that are politically difficult to remove. The government then wonders why the revenue stream decreases. But, because the spending is sticky, it cannot adjust. So, the government must become more hard nosed and draconian in order to drive ever more revenue.

This is somewhat akin to the government’s approach in general. But, with general tax, the government also ignores the growth effect of taxation. As indicated before, the higher the tax is, the lower the net benefit of working more or taking more risk. But, if your spending is to increase, you need growth to finance it. So, the government strangles growth and strangles revenue, and wonders what is going wrong. It is akin to Winston Chruchill’s statement that “a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.” And, Margaret Thatcher’s statement that “the problem with socialism is that you eventually run out of other peoples’ money”.

Government is not run by the smartest people, however. To use Australia as an example, the treasurer has never held a private sector job, has always been within the government and think-tank arena, and has a PhD in political science. His PhD thesis was a dissertation on a former prime minister – Paul Keating. His dissertation had no economics or accounting and he has no background in finance, economics, or accounting. This situation is not uncommon in Australia. It is little wonder that Australia has such failed policies.

The situation is unlikely to change, however. Australia’s approach is not uncommon. Myriad countries take a similar approach. But, Australia’s attempt to tax itself into prosperity, and its surprise at the rise in organized crime, should serve as cautionary tale.

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The RBA’s stated reason for cutting rates is:

“In the December quarter underlying inflation was 3.2 per cent, which suggests inflationary pressures are easing a little more quickly than expected. There has also been continued subdued growth in private demand and wage pressures have eased. These factors give the Board more confidence that inflation is moving sustainably towards the midpoint of the 2–3 per cent target range.”

The RBA’s stated logic is curious, however. The RBA ideally aims to get underlying inflation towards the midpoint of its target range (i.e. 2.5%). However, the RBA’s own forecasts suggest that the proxy for underlying inflation is expected to remain above 2.5% throughout its target period. Furthermore, the RBA stated:

“The forecasts published today suggest that, if monetary policy is eased too much too soon, disinflation could stall, and inflation would settle above the midpoint of the target range. In removing a little of the policy restrictiveness in its decision today, the Board acknowledges that progress has been made but is cautious about the outlook.”

We can start with the political pressure. The ruling Australian Labor party has been suffering in the polls, with a strong possibility that they will lose seats in the House of Representatives and be unable to form majority government. Thus, there are reports that members of parliament were calling for the RBA to cut rates. Political pressure is unlikely to cause a rate cut if it were not already a possibility. However, in a close decision, a rational agent might err on the side of reducing political blowback. Unfortunately for the RBA, the appearance of political influence opens the RBA to criticism.

The RBA faces a further conundrum. Inflation remains high due to government spending. This is clear from the factors that contribute to Australian GDP growth: Government spending is offsetting a faltering private sector. However, such spending is myopic as it increases inflation. In response to the inflation and interest rates, the Government has enacted subsidies, which tautologically involve more spending. These subsidies temporarily reduce price growth and headline inflation. The RBA sees through this charade but the federal government can falsely claim that it has reduced inflation. The net result is that government spending exacerbates underlying inflation even if it temporarily reduces headline inflation, which triggers elevated interest rates, which triggers more government spending, which keeps rates higher for longer. But, unfortunately, the people impacted by the higher rates do not receive the subsidies in a proportionate manner. Thus, those on the receiving end of the higher rates ultimately bear the cost of bad fiscal policy.

A further wrinkle is labor productivity. The RBA has noted that poor labor productivity risks exacerbating inflation. That is, if productivity increases, then (in simple terms) it costs less to produce the same amount of output. By contrast, if productivity falls, it costs more. In Australia, GDP per hour worked – the estimate of productivity – fell 0.8% y/y in the latest release (Q3, 2024). The RBA also suggests hat it will fall leading to June 2025.

Going forward, it is uncertain whether and when underlying will approach the RBA’s target. The RBA forecasts underlying (i.e., trimmed mean) inflation to remain at least 2.7% during their forecast period. However, the RBA also suggests that the cash rate could approach 3.6% by December 2025. Whether this is realistic or wishful thinking could depend on whether governments can restrain their election spending and fiscal stimulus during the election campaign.

There are reports that the ALP is once again considering raising property taxes to reclaim the narrative, and if not now, then when the Prime Minister moves on.

The fundamental issue, however, is that investing is the only way to achieve freedom in Australia. Everyone should aspire to invest, and invest as much as possible. Albanese used his investment to buy his dream home. This is an aspirational and laudable outcome. We should celebrate such success, not tear it down.

What’s more, every Australian should do the same. Wages do not keep pace with inflation. This is especially so on an after-tax basis as bracket creep seizes an increasing slice of earnings. Workers often find themselves in a never-ending cycle of working harder to achieve less. The only way to avoid being an indentured servant to your corporation is to invest.

Thus any attack on investing is an attack on individual liberty and freedom. It constitutes an attempt to render people slaves to the corporation and to the state.

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Governments should encourage everyone to get ahead, not tear them down for doing so. Governments should try to grow the economic pie, not look to steal from one person to give to another. Unfortunately, Albanese, Jim Chalmers and the ALP have taken the shallow and divisive path, launching an attack on ambition and hard work.

The latest flashpoint is negative gearing and the capital gains tax discount. Albanese has been inconsistent about changing these, despite having clearly benefited from them. He has suggested he is not looking at, or intending to, change these rules. And the federal Treasurer has assured us the government is “not going that path”. But where have we heard that before?

This should concern people whether or not they have an investment property. After all, all Australians should aspire to have as many investments as possible; investing is the way to get ahead in this country. There should be more investments, not less.

And let’s be clear: much of the rhetoric over investing presupposes people buy the perfect property in the perfect location with a high deposit. In reality, you can invest in a small apartment with less than 10 per cent deposit. You just need to ask a good mortgage broker for advice. It’s all about starting the journey.

Any attack on negative gearing is duplicitous. Politicians pretend that negative gearing is a subsidy or a gift from the government. It is not a subsidy. It is not a credit. It is not a benefit from the government. It is a pithy term for what is standard practice.

The concept of negative gearing merely involves deducting expenses from revenues to look at the overall net profit. In no other context is it remotely controversial to deduct an input cost from revenue. Businesses do this routinely as a matter of course.

Similarly, any attack on capital gains tax discounts is disingenuous. There is a strong argument for reducing taxes on labour but there is no argument for increasing taxes on capital gains.

After all, when an individual invests, they have invested their own after-tax money into an asset. They have already been taxed. The government is double dipping. The capital gains tax discount should be closer to 100 per cent and should most certainly not be reduced.

Increasing CGT also would have unintended consequences; it would significantly reduce transaction volumes. This is because a seller would have less capital left over after selling, deterring them from doing so.

Suppose an investor has $500,000 equity in a $1m property. If they sell, they keep about $375,000 of the gains. If the CGT discount is reduced to 25 per cent, they keep only $312,500. This reduces the capital for a future purchase, deterring them from doing so. In turn, transaction volumes would fall. Ironically, as we have seen in the US, this can support prices as more owners stay put and supply falls.

When an individual invests, they take the risk and make the sacrifice of putting forward their capital. When they do so, they tie up their capital. They could have used that money for entertainment. But they sacrificed.

They also risk losing money. Perhaps the property requires extensive maintenance. Perhaps it is in a bad area and falls in value. Perhaps a tenant trashes it. They also bear the risk of financial distress if their financial situation changes. Gains from deploying capital are different from gains from working.

Such problems are only one part of the story: attacking negative gearing and increasing capital gains tax will only worsen the housing crisis. This is because the population is growing faster than is housing supply. If you want more housing, you need more construction. But construction is expensive. And builders must charge enough to stay solvent. Ergo, you need investors.

But if investors’ after-tax cash flows fall, so will their willingness to invest in new builds. The drop in investors will result in a drop in construction, which will result in an ultimate increase in rents.

Restricting negative gearing to new builds is not a solution. Any investor in a new build will consider what future buyers will think after they sell. Thus, it will not incentivise investment in new builds because investors are not myopic or foolish.

This month’s book spans a slightly dry subject matter: mathematics. I’ve been using it mainly as a light diversion and a ‘brain warm up’, akin to solving crossword puzzles or sudoku.

What exactly is the book?

This is a quasi-mathematics textbook. It is relatively simple. For example, it covers basic calculus, algebra, and optimization. For people who have done a PhD in economics or finance, this is second nature... until they forget the material, courtesy of disuse. The book is methodical and does not take previous knowledge for granted. This compares favorably with most economics books, which seem to assume mathematical knowledge. It is well paced. Mostly. Some sections are too long. But, they are easy to skip. The book has myriad exercises, which is mostly where my attention went.

Who is it for?

I see the book as having a few use-cases:

a) It is useful for undergrads in the field and/or for graduate students who come from more of a qualitative background. This can include as useful-to-essential reading before starting a more rigorous graduate course.

b) My use case: brain warm-up and problem solving. I do various exercise sets from it , much like you would do warm up sets at the gym. You can think of it as being similar to doing a crossword puzzle or sudoku. The material is not challenging. That is the point. It ceases to be a warm up if you actually need to think when doing the problem questions. The book is diversionary and distracting without being fatiguing. My use case – as a just a series of mini-puzzles – might be idiosyncratic.

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Is it worth it?

Yes and for both the aforementioned use-cases.

For students: Unfortunately, mathematics seems to have been excised from commerce degrees. This is a problem as universities are now inflicting barely numerate ESG analysts (activists?) on industry. But, if an ESG "analyst" cannot understand the papers that analyze the relationship between ESG, its components, and returns, then that ESG analyst is useless. Don't be that ESG analyst. The mathematics are a useful counterweight as they are a precursor to understanding the empirical evidence. I posit that commerce degrees should reintroduce basic mathematics.

For my use case, it's also been positive-utility. I have gotten more than enough hours of diversion/procrastination from it. I am satisfied with the purchase and it was value-for-money.

Let’s start with what Clare O’Neil said. She indicated that housing prices should increase over time in an ‘ordinary’ manner. Supply should increase. However, supply should increase organically and the market will provide supply over time. This is a relatively standard approach to markets. Let the market produce more supply and it will do so if it makes financial sense.

The controversy was the implication that prices should increase.

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Now, let’s unpackage what her detractors seem to say. Some assert that prices can dip and oscillate in any market. Thus, the idea that prices ‘always’ increase is silly. And, attempting to force an increase is bad policy. This too is true, in general. However, there are some caveats, which we will see below.

The major issue arises with the counterfactual and the seeming implication that house prices should not rise, that house prices should fall, and, by implication, that the government should force such declines. This appears to be the crux of the animus towards Clare O’Neil. She did not say the ‘correct’ or ‘trendy’ thing for a certain section of the loud online commentariat. In turn, the detractors imply that the government should force down prices.

The detractors appear to believe that it is not enough to increase supply. Rather, the government must actively drive down prices through policies that are tantamount to engineered deflation and implicit price ceilings. For example, the government could do so by hiking taxes or supposed concessions, which are not really concessions but are characterized as such by people who like high taxes.

The first major problem is deflation is bad for markets. The reason is easy to see. If you know an item will cost less tomorrow, you will buy it tomorrow rather than today. Knowing this, sellers will produce less because they anticipate demand will be less. In an ordinary market, this will resolve by ordinary supply and demand.

But, what happens if the government says – or implies – it will force prices to keep falling and not rise? Well, here, developers know that if they build now, they risk losing money on a build. Thus, they will not build. Owner-occupiers will know that they could buy cheaper next year, so they will not buy. Investor will now that their investment will fall in value, so they will not invest. Thus, the quantity of new supply will fall. Now, in an ordinary market, this would cause prices to increase. Then, supply would increase. The market would resolve.

But we have a problem: the people who want prices to fall implicitly want a price ceiling to keep prices falling. This appears to be a declining price ceiling. At least until they have bought a house, then they’re happy for prices to start increasing, it seems. In any case, we now have the problem of price ceilings. This is a textbook issue: in a price ceiling the quantity supplied will fall well short of the quantity demanded. This exacerbates the housing supply issue.

What happens when new supply crunches? Well, it is a challenging issue. Presumably, government policy would be the bulwark that breaks and we would need an about face. But, that is a large risk. Until then, rents would rise, which might help to offset the capital loss that the government had inflicted. In turn, this might force more people to reside in each dwelling, reducing the appearance of demand but also reducing individuals happiness.

The sum total of this forced deflation proposal is disaster. Supply gets worse. Because there is an implicit ceiling or control stopping prices from rising when supply falls, the market cannot resolve itself.

The implication of this is that Clare O’Neil is right because the counterfactual leads to bad results. We need an ‘ordinary’ level of inflation, much like we do in any market. There is a reason central banks avoid deflation. There is a reason price controls do not exist: they are bad policy. The best approach is to leave most policies alone. The continued musings about negative gearing and CGT do not help matters: they raise the risk of the aforementioned adverse situation. And, risks matter. The government should just allow more supply so that the market can resolve itself organically.

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In the final parliamentary sitting day of 2024, the government rammed through a slew of more than 30 Bills. Quite how a bill could be scrutinized in the space of 15 minutes is unclear. But, nevertheless, the ALP persisted. Amongst this charade of a democratic process, was a bill to change the RBA board.

The Bill effectively splits the RBA’s board into a ‘governance board’ and a ‘monetary policy board’, the latter of which sets interest rates. Both the monetary policy board and the governance board have nine members: three from the RBA and six external members. The treasurer appoints those six external members.

This is a significant concern. Currently, the RBA has six external appointees. Four are coalition appointments; two are Labor appointments. Those two are former union officials. With the changes, Jim Chalmers can appoint another six RBA members, bringing the number of labor-aligned appointments to eight. This effectively allows Jim Chalmers to stack the RBA boards and exert control over at least one of the RBA boards. That control is implicit: he cannot explicitly direct the board, but can appoint ideological travelers that he is sure will act in the same way he will act.

The problem is obvious: the treasurer can appoint apparatchiks. And, even if you like Jim Chalmers, do you then trust the Coalition to make better appointments when it is in power?

The clear fear is that this is an attempt to procure a compliant RBA before the election. After all, Labor hopes for a rate cut before the next federal election. Jim Chalmers has repeatedly made misleading statements about inflation, which the ABS’s own inflation reports contradict. Specifically, the ABS has noted that the reason headline inflation appears low is because of temporary energy subsidies, which will not persist, whereupon inflation will mechanically spring back.

How then could this be improved? Well, an appropriate vetting process could help. This could involve candidates being approved in the Senate, akin to how cabinet positions are approved in the US. This could reduce party-political appointments by forcing the treasurer’s picks to secure broader support. However, such changes are unlikely to occur. After all, when the opposition becomes the government, it too will seek to redress the balance.

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Jim Chalmers has claimed to be “modernizing” the Future Fund to make it “stronger, more successful, and more sustainable”. He asserted that the Future Fund will “still maximize its returns but it will also deliver for Australians by investing in energy, housing and infrastructure”.

Jim Chalmers’s assertions demonstrate a complete lack of understanding of basic portfolio construction.

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It is axiomatic that a constrained portfolio cannot outperform an unconstrained portfolio except in very specific circumstances. Those include that the constraints give better access to quality deals that would otherwise be unavailable, the constraints help with capital raising and hitting a critical mass of funds under management, or the constraints otherwise lead to a mass of expertise, and talent that would have been unavailable otherwise.

There is no justification for forcing the Future Fund to devote part of its portfolio and imposing such a constraint. The Future Fund already can, and does, hire talent across the field. The Future Fund does not need a constraint to raise outside capital. The Future Fund already has access to quality deals and a constraint is unnecessary for it to access any additional deal or investment. In short, if an investment is good, the Future Fund is well capable of investing in it already.

These basic mathematical facts highlight the absurdity of Jim Chalmers’ stance. If ‘affordable housing’, or ‘renewable energy’ were good investments, the Future Fund would already do them. Indeed, the Future Fund is involved in some energy-related investments and funds already. But, the additional focus and mandate would now force the Future Fund to invest in lower quality investments that deliver lower returns, higher risk, or both.

Jim Chalmers is wrong, and he is spreading economic misinformation that would run afoul of the ALP’s Misinformation and Disinformation Bill were it to be law. Either Jim Chalmers does not understand basic portfolio construction, or he does not care.

An independent Future Fund can deliver outcomes in a much smarter way than Jim Chalmers proposes. A fully independent Future Fund, with an appropriate benchmark, should be run entirely at arms length. Should the Future Fund beat the benchmark after fees, then it could pay 20% of the performance above that benchmark back into the government. The remaining 80% would be reinvested in the fund to grow it. This would resemble the performance fee that a fund manager might earn, but ironically, here, the performance fee would be paid to the investor. Under no circumstances should the government direct the Future Fund to invest in specific priorities or raid money from the future fund.

Unfortunately, however, whenever a pot of money exists, the government treats it as a magic pudding to raid. We have seen this with the reprehensible raid on superannuation via Division 296. We are now seeing it with the Future Fund.

The Future Fund raid sets a bad precedent. It signals to future governments that they can direct the Future Fund to invest in their personal ideological foibles. Thus, even if you agree with Jim Chalmers’ priorities, you might not agree with Peter Dutton’s. Jim Chalmers has now opened the Pandora’s Box of political shenanigans.

The net result is that we all lose. The Future Fund is supposed to generate wealth, potential to be able to pay dividends when required. But, this is contingent on the Future Fund not being raided or hamstrung along the way. The government and Jim Chalmers are doing just that.

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