Supply side economics & what it means for property investment.

Government revenue shortfalls are the talk of the town at the moment, so today I’ll take a brief look at the arguments for and against what economists call supply-side economics, and what it potentially all means for Australia as well as those of us interested in property investment.Traditionally, the concepts of supply-side economics encapsulated a range of ideas and advocates were generally those in favour of free market economies.

Thus ‘supply-siders’ would talk in favour of the abolition of monopolies, privatisation of utilities and allowing markets a free reign.

As is often the case, the usage of the term morphed over time and supply-siders are now generally simply thought to be those in favour of lower tax rates to benefit the economy as a whole.

Their argument is that higher tax rates, such as those seen in earlier post-war decades, provide a disincentive for high income earners to work hard and sometimes sees the wealthy relocating to tax havens.

Consequently, they argue that high tax rates cause low productivity and eventually even lower tax revenues for the government (whereas logically, of course, you would expect higher tax rates to bring in more revenue).

These ideas found favour in the 1980s as Margaret Thatcher and Ronald Reagan promoted lower tax rates, which led to George Bush infamously labelling the ideas as “voodoo economics”, meaning that the tax cuts would have to be paid for by later generations.

In fact, most detailed studies have tended to agree with Bush – dropping tax rates does, overall, simply reduce government revenue as logic would indeed imply.

GFC

This all came very much back into focus in Britain during the financial crisis when the UK government hiked up the top band of tax by an emergency 5% in a bid to fund the necessary stimulatory spending.

Many tax experts argued that this simply disincentivised productivity, and in today’s more fluid world, saw more high-earning Brits moving overseas.

Tax revenues, they said, did not improve at all for the emergency higher tax band.

The Laffer Curve

These ideas were summarised a few decades ago now by the concept of the Laffer Curve, an economic theory promoted by Arthur Laffer, as legend has it, on the back of a napkin.

His basic idea was that as tax rates move closer to 100%, incentive to work falls and so do revenues. Naturally, if tax rates are too low then revenues are also very low and this leaves the government with a shortfall to pay for social security costs, infrastructure, education, defence and so on.

The trick is to find the optimum rate of tax on Laffer’s bell curve to keep workers incentivised and tax revenues sound.

The optimum rate of tax

Through the last century we had two world wars which resulted in some major economies lurching towards very high rates of tax.

It is now well accepted that this is counter-productive and hinders growth. As a result, only three countries in the world have a top rate of tax of 60% or above.

In Australia, we currently have a relatively high top band tax rate of 45% plus a 1.5% Medicare Levy, giving an effective tax rate on top bracket income of 46.5%.

The future for Australia

In one sense in Australia, we are lucky.

As a resources exporting country, we do not need to run our annual government budgets at an enormous deficit, in stark contrast to countries such as the US where the national debt increases year after year up to a level of well over $16 trillion today.

Whether or not the US is able to continue to increase its national debt in any sustainable manner for decades to come without causing a flight from the currency is another matter entirely.

In Australia, though, we have a problem of a different nature, and that is that we have millions of our workforce heading into retirement with greater life expectancies than ever before.

While the superannuation system has been a welcome development, most of those heading into retirement today do not have pension balances at remotely high enough levels to fund a full retirement.

Thus, government coffers come under great strain as Age Pension and Medicare costs mount.

Yet, with a top rate of tax already at 46.5%, there is very little room for manoeuvre on the marginal tax bands.

In fact, if you earn just $80,001 today, you are already being slugged with income tax at a high marginal rate of 37%. Realistically, the government can’t move tax rates too much higher without hindering economic growth.

 

Taxable income Tax on this income
0 – $18,200 Nil
$18,201 – $37,000 19c for each $1 over $18,200
$37,001 – $80,000 $3,572 plus 32.5c for each $1 over $37,000
$80,001 – $180,000 $17,547 plus 37c for each $1 over $80,000
$180,001 and over $54,547 plus 45c for each $1 over $180,000

Source: ATO

Big Australia

So, yet again, we always seem to come back to the same point for the future of Australia: populate or perish.

Unfortunately, politicians, while accepting that immigration is the only available route for Australia to take, do not want to be personally or politically associated with the idea of the Big Australia.

Instead, we find ourselves in the remarkably curious position of having a rapidly growing population which nobody wants to discuss.

The latest ABS figures showed that the population of Australia increased by around 360,000 people over the last measured 12 month period.

Stop to consider for a moment, what that rate of growth will do to the relatively modest population of Australia over the next few decades. An extra 10 or 11 million people: the Australia as we know it today will be virtually unrecognisable.

Our four major capital cities will be bursting at the seams, infrastructure will have to be developed massively, we will need to construct millions of new dwellings (especially as household sizes continue to reduce) and our living styles will be much more in tune with those seen in the major Asian conurbations.

And if that isn’t food for thought, I honestly don’t know what is!

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Pete Wargent

About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


'Supply side economics & what it means for property investment.' have 5 comments

  1. March 4, 2013 @ 11:33 am opinder

    Hi Pete,
    Very sensible and eye opening article..Thanks..

    One question I want to ask you Pete its not based on this article…In your investing career have you ever made any mistake or any losses while Investing..Would you mind sharing that one day..
    Thanks kindly

    Reply

    • March 4, 2013 @ 7:38 pm Vaughan

      Dear Opinder,
      There is going to be a lot of bull spoken about tax in the lead up to the next Federal election.
      Please also consider the following, as you develop your view about too much, or too little taxation.

      Last time I checked (and it is a little while ago I admit) only about 5% of the population earned over $100,000 and only 1% earned over $150,000 a year. Current figures may well have changed, but they will not have changed all that much.

      From Pete’s table, we can see that our mate who earns $80,001 pays $17,547.37 which is 21.93% tax. And our little mate who earns $180,001 pays $54,547.45 which is 30.3% tax.

      When commentators keep referring to the marginal tax rates i.e. 37% marginal rate not the 21.93% actual rate on $80,001 or the 45% marginal rate not the 30.3% actual rate on $180,001 as Pete has, it only muddies the water further. Then everyone gets all hot under the collar, thinking that they are paying all this tax out of their hard earned income, when they are actually not paying anything like these often quoted marginal rates at all.

      This mis-reporting of the tax rates makes it very hard to hold an informed view, or have a discussion on the topic; especially when the true rates, as in these two examples, are only about 60% and 67% of their quoted marginal rates. Now that is what I call a tax cut!!!!

      Everyone I know wants to live in a civil society where important services are available to all of us, regardless of our wealth. To do this we all have to pay tax, in some way. Sometimes I think those complaining the most, are probably crying all the way to the bank.

      Tax is an important policy issue that goes way beyond avarice. And it should be treated with the importance it deserves.

      Reply

  2. Pete Wargent

    March 4, 2013 @ 12:01 pm Pete Wargent

    Hi Opinder, I certainly can, but the list would be longer than the article itself! I’ll write a post on the subject one day. Where to start?…in no particular order:

    Not starting investing when I was 18, trying to smash the market return by buying speculative stocks, not using sell-stops, having a lack of diversification, trading too often…

    And in property: paying too much/not negotiating hard enough, buying apartments with high strata fees, fixing rates at the wrong point in the cycle (I blame my faulty crystal ball), believing that solicitors read all paperwork in detail, forgetting that the deal of the century comes around about once a fortnight…

    Interestingly though, for all the mistakes I’ve made in property, I don’t own any properties which do not have a substantial amount of equity in them, which shows that the asset class tends to be forgiving of mistakes over time. So the single biggest mistake I have made was not starting earlier.

    As for the best financial decision: not selling even in the years when everyone was claiming that the world was ending (1997 Asia crisis, 2000 tech bubble, 2001 September 11 attacks, 2007 sub-prime crisis, 2008 Steve Keen’s “40% crash”, 2009 global financial crisis, 2010 flash crash, 2011 European debt crisis, 2012 fiscal cliff…)…

    Reply

  3. March 4, 2013 @ 5:56 pm opinder

    Hi Pete
    many many thanks for sharing..yes I would love to read your
    article on this oneday although I keep reading your blog and book everday..
    Big motivation for me..
    Thanks for sharing..Regards

    Reply

  4. Pete Wargent

    March 4, 2013 @ 7:52 pm Pete Wargent

    Vaughan, I can’t disagree with any of that. Very complex debate – it’s true that other countries have higher burdens than we do and there’s been a lot of debate about whether mining companies should pay a greater share, and so on. I suspect what most Aussies are most concerned about is the way the levied tax is spent.

    Reply


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