My impression has always been that one of the fundamental reasons for tax was to proxy for a social return on a nations capital – such as land.  By doing this we get the advantage of actual property rights on land, even though in essence we hold a belief that society as a whole owns that land.

Now my impression of this debate is that NZ society DOES believe it implicitly owns the land.  If we had a land tax that proxied the “rental income” for society, it wouldn’t matter who owned the property right to use the land and this whole debate about foreign ownership could be chucked out the window.

Another point in favour of land tax is it?

Update:  Danylmc at Dim Post discusses the same article.  I’m not sure I would interpret history the same way as him – was there really much of a cost from the running down of our grossly inefficient railway system?  However, lets not argue about this point here – as it is peripheral to both posts.  There are two primary points that need to be raised beyond my land tax call above.

Firstly, if the problem is that the government sold the asset too cheaply, then we should raise that as the issue.

Secondly the arbitrary idea of a “strategic asset” might crop up – if we want to think along these lines, lets actually do some thinking.  We should ask “is it a public good”, “are there competition issues” and/or “are there externalities from the assets use”.  If these things hold, then we can ask what is the best way to define ownership.

Yes there are cases where the government should own assets – but they should be determined by analysis instead of arbitrary catch phrases like “strategic asset”.  Obviously there are too many management consultants floating around government at the moment given the amount that term is floating about.

However, there is no issue with selling companies in of itself.

The “problem” might be that, as a whole, New Zealand residents appear to own a significant amount relative to their income and wealth.

If we do believe this is the case, then we have to ask why. Just saying “look we are selling stuff”, “look NZ owes some stuff” doesn’t tell us why this is the case, whether this is a problem, and if it is a problem what we can do about it.

If we think that there is some systematic risk from this behaviour, or that New Zealand residents do not recognise the risk associated with this level of risk, then we should be looking for policies that will improve said decision making – not arbitrarily looking at policies that will “force” saving or the voluntary sale of goods, services, or assets.

Is this point of view unreasonable? If we accept this point of view, we also have to accept that other New Zealanders might want to consume now, or may want to avoid the risk associated with “high return” ventures.  Given this, it is both unreasonable and harmful to social welfare to try and force New Zealanders to save to effectively subsidise the risk of business owners – which is what compulsory savings will be.

“We know that there are a lot of cold damp rentals out there and that lots of people have to live in them because they don’t have the money to move.”

Exactly, so by reducing the supply of rental properties and driving up their price, this bill will ensure that students who move to the city to get access to university won’t be able to – and so will have their lifetime options cut down.  That is exactly what would have happened to me, if I hadn’t have been able to live in dingy dingy properties.

And of course, this ignores the costs of administering the scheme – are we going to have people constantly patrolling flats for quality now?  Won’t this lead to “black-market” rentals.  If they think there are external benefits to insulation, subsidise the damn thing – don’t run around with poorly thought out policy like this please.

Anyway, I’m off to watch the Phoenix play …

The reason why I find this way of looking at tax changes strange is that it ignores how prices change in response to the structure of the tax system.  I fear that, to many people, this seems like a benign (possibly even esoteric) issue – when actually it is one of the most essential issues to keep in mind when thinking about the design of a tax system.

Partial equilibrium

The first step required to analyse this is our good friend the “economic scissors” – or supply and demand.  The introduction of a tax creates a “wedge” between our supply and demand curves, which in turn implies that the quantity produced in the industry is lower, and the prices faced by the supplier and the purchaser are different.

Now in the case of the labour market, the purchaser is a firm and the suppliers are workers.  Only by looking at how responsive supply and demand are to changes in the “price” (wages)  can we infer what will happen when we change the tax rate – both to the welfare of the individuals in the market and the output produced in the market.

Update:  Eric Crampton discusses experimental evidence that shows where people struggle with this concept.

General equilibrium

However, our scissors only take us so far.  The labour market is not independent of other markets out in society.  A higher tax in the labour market implies that input costs are higher in the goods market – a factor that influences prices and output.  Furthermore, lower production in the labour market implies just that – lower production/output.

Given the general nature of a tax on all labour income, and given the fact that labour is an input, it is not really clear exactly how a tax on one group will impact on everyone is society.  It is possible to say that, although a tax on the wealthy which redistributes will make the poor relatively better off – it may also make them worse off in an absolute sense [note, this is not inconsistent with the second welfare theorem as a labour tax has a supply side impact that a "redistribution of endowments" does not].  Now I don’t believe that we are near a stage where this is the case – but it does illustrate that the idea of redistribution is inherently fraught with complications.

Time path

Furthermore, the welfare costs of the transition between different tax systems are inherently difficult to understand.  Saying that so-and-so gets a $Y a week tax cut may be true in that very moment of time – but within a year the path of prices in the goods market, the negotiation of wages in the labour market, and the path of government spending will all have likely changed relative to their pre-tax cut level.

As a result, how this transition functions has costs and benefits in of itself – which is also an important issue to understand.

Conclusion

As we have described above, the issue of “redistribution” through “labour tax” is unclear.  This is one of the primary reasons why economists like the idea of a “flat tax” – since the redistributive impact of progressive taxation in itself is unclear.

If we combine a flat tax system with a targeted benefit system (which is based on both extensive research and an exploration of societies preference for redistribution) we have a clear and transparent equity-efficiency trade-off.  This seems like an appropriate way of forming, and then fulfilling, our social contract.

However, the same people complaining about the $Y a week so-and-so gets would criticise such a shift to a flat tax system on the same grounds.  Hopefully, by pointing out that such a static view of tax changes doesn’t make sense we can help put the desires for a more transparent tax system in context.

I would like to point out that when an economist does analysis they don’t give two-cents worth of a care to this.  When it comes to making a policy it is essential, but it isn’t part of the first stage of description.

It is just like the “equity” trade-off with efficiency in economic analysis.  Economists focus on efficiency when describing a situation – but there are welfare trade-offs which imply that a policy based solely on efficiency is unlikely to be socially optimal.  An economist can go so far as discussing the trade-off by describing how deviations from the efficient allocation work – but they can’t sit down and say “this is what society wants”.

In the same way, I have no doubt that political actions are politically optimal – they are being determined by utility maximising individuals after all .  However, just because it is politically optimal doesn’t mean anything to me when I’m trying to discuss the framework and trade-offs inherent in the policy.

However, I have noticed that pointing out these trade-offs relative to the way political parties have been marketing themselves leads to a HEAVY amount of emotion and argument – which is fun. I suspect this is part of the partisan nature of politics.  I hope that people from each party understand that I attack all political parties on this blog with equal boring economic analysis, and some (hopefully transparent) priors.

Over the last few weeks it has also taught me that there are a number issues many of the parties don’t understand very well – even regarding their own policies.

Update:  To be absolutely clear here, I am talking about the political parties – not the excellent comments and emails that I have received from people about the issues.  The comments and emails have been intelligent and balanced, and I appreciated them greatly.  Furthermore, the criticism is not just of ACT and the Greens (given my recent posts about those parties) it is equally about ALL parties.  Fundamentally the discussion around policies has exposed confusion all around the show in my opinion.

This is fascinating, as I had assumed the parties were being manipulative rather than confused.  If I had to vote right now, I would struggle to pick anyone :/

Of course, I’m not too worried about this feeling – as I think political parties try to give the impression that they do a lot more than they actually do, be it the result of abridled ego or straight self-deciption

Email one – fiscal policy, and why it may be preferable

http://economistsview.typepad.com/economistsview/2010/05/modern-macroeconomic-theory-and-fiscal-policy.html

This link discusses some of the modern justification for “demand side” policies during a significant recession.

Note, when they say “demand side policies” this can mean either monetary policy or the government buying things.

The people that want higher fiscal policy fall into two (often intersecting) camps:

1. They just want higher government spending to start with,
2. They believe that once interest rates are close to zero we hit a “liquidity trap”.

I don’t believe in liquidity traps per see, as when we have a liquidity trap the issue is that we can’t cut interest rates.  However, we can “print money” and buy things with that money – and if the real interest rate doesn’t fall (nominal rates – inflation) then we are effectively getting higher production for nothing …

That is the key – we could create inflation to get out of the environment.  Now in the liquidity trap view there are two reasons why we have a liquidity trap:

1. We can’t print money and buy stuff to create inflation
2. We won’t print money to buy stuff and create inflation

The first view is just weird.  The second view is actually fairly accurate – central banks are nervous about “just printing money” as they get attacked about “hyperinflation”.  Of course, there is a gap between “deflation” and “hyperinflation” but if central banks just start printing money, and inflation expectations get loose as a result, we will have a more unstable environment.

As a result, fiscal policy can be seen as preferable if we think printing money would cause instability.

Email two – batting for New Keynesians

Here is more from Thoma,

http://economistsview.typepad.com/economistsview/2010/05/whos-really-standing-in-the-way-of-progress-on-macroeconomic-theory.html

He has good points, but I think he is too negative about the ability to adapt New Keynesian models – New Keynesian models are frameworks, the problem is that we haven’t got sophisticated enough descriptive knowledge to really get the most out of the framework.

Krugman is here:

http://krugman.blogs.nytimes.com/2010/05/24/oy-macro/

He is writing as someone who pushed fiscal policy, and refused to really listen to/fairly represent the other side.  Deep down Krugman is in the “the zero rate doesn’t have to matter, but policy will be such that the zero rate is a constraint” camp.  But he acts as if he is in the “at zero monetary policy is useless” camp.

Currently a significant portion of Government capital is tied up in the SOEs, around $40 billion dollars (around four times the size of the largest projected Government deficit).

SOEs perform, as a class, very poorly. Recent reports suggest that in the last financial year they returned 1.5% on equity. This is below the risk free rate of return.

Such poor allocation has real costs to the New Zealand economy. The opportunity cost of maintaining investment in such low returning assets (as a whole) effectively amounts to taxpayer resources being wasted.

It is therefore very worthwhile that the Government looks at its investments and considers whether SOEs might be better placed in the private sector’s hands.

In other countries there are often many competing institutions offering odds on various events, including sports. In fact, there are now many companies that operate across borders in many countries,  such as BetFair and Bet365.*

The lack of competition in the betting market in New Zealand stifles innovation in the betting options they offer. One recent pundit proclaimed the TAB “the most conservative betting agency in the world”. Essentially the TAB has no incentive to innovate, as they know punters have limited ability to legally gamble through other avenues.

The TAB have started opening more interesting books on the FIFA World Cup, such as whether Lionel Messi will score more goals during the campaign than the All Whites combined (Messi the hot favourite at $1.55!).

If the gambling market were officially opened up to competition I suspect we would see a lot more of this innovation.

*I’m not sure of the legal status of these organisations in New Zealand, although I understand it is possible to open accounts with them (legally or otherwise).

Government has set a prosperity target, to match Australia’s GDP per capita by 2025.

Efforts to increase the availability of capital for productive firms and to innovate more effectively are important steps in the right direction, but effort improvement should contribute too.

Labour productivity, the output per hour worked, is the most significant driver of a nation’s GDP per capita. New Zealand performs relatively poorly on measures of labour productivity, ranking 22nd of 30 OECD countries, whereas Australia ranks 13th.

Improving labour productivity can be achieved by improving, amongst other factors, contributions from innovation, capital and effort.  Flagellation motivates managers and workers to find ways to produce more valuable output per hour worked.

Growing New Zealand’s prosperity depends on developing successful international businesses, and businesses will only be successful if they are competitive. Achieving competitiveness, by providing more valuable products and services or by having lower cost structures, requires world-class effort.

The target to match Australia’s GDP per capita by 2025 is ambitious. Effort improvement is only part of the solution but it is very important.

On a serious note, an individual’s decision to develop skills and the such is part of their choice given the payoffs available in the labour market.  If we are going to subsidise it let’s actually try to figure out what the “public returns” are from this education – rather than spouting off truisms regarding labour productivity or flagellation.

Again, remember that the purpose of policy is to improve/maximise welfare – not to meet GDP targets or redesign the economy/society in our own image …

Without compulsory work New Zealand is destined to become an economic backwater. Our relative standard of living, particularly when compared to Australia, will continue to decline.

Two important actions can reverse our long term economic decline, effective labour market regulation and compulsory work.

Compulsory work had been an unmitigated success in the New World and has helped transform their economy. While NZ academics can argue about whether or not it has increased their overall savings rate, it is clear that it has improved the amount that is produced in the economy.

Moving back away from the sarcasm let me say:

• Compulsory superannuation is the love child of fund managers – as they can’t see past the idea that “more savings = more funds = more investment”.
• Even those that do see past self interest only think of “GDP”.  However, the goal of policy is to maximise welfare not output – if people want to consume they should be allowed.  Forcing people to save is abhorrent.
• Yes compulsory saving leads to more saving, and possibly to more investment (at least to lower borrowing).  But it does this by making people credit constrained – implying that people can’t smooth consumption over time and have lower lifetime satisfaction.

To me, compulsory superannuation/saving schemes are very wrong.  The people trying to push them need to learn that the purpose of policy isn’t to increase GDP or fatten their wallet, it is to ensure that we have a society where welfare is maximised.