From: c.oneill@trl.oz.au (Chris O'Neill)
Subject: Re: Australia's Debt : IBIS view
Organization: Telecom Australia Research Laboratories
Date: Tue, 10 Nov 1992 02:17:21 GMT

In article <1992Nov9.110227.7510@trl.oz.au> andrew@medici.trl.OZ.AU (Andrew
Jennings) writes:
>
>I've been thinking about that post about our trade performance, and
>how its improving. I think this article encapsulates the reasons
>why its clearly not enough just to do this. 
>
>
>From the "Daily Commercial News" Monday November 2, written by Pauline
>Zahra.
>
>
>The federal government's insistence that the balance of payments
>problem could be solved by increasing exports was "propaganda" and
>Australia was heading for disaster.
>
>This is the view of Phil Ruthven, executive director of IBIS Business
>Information Services who predicted that the payments deficit was fast
>approaching the previous record of $23 billion, set in 1989-90.
>
>Mr Ruthven told DCN the government's ploy of encouraging exports and
>import replacements was paramount to "persistent lies" because the
>major item causing the deficit was the climbing interest rate on the
>foreign debt.
>
>Mr Ruthven said the merchandise balance of trade had improved in the
>past few years and had been in surplus several times this year but the
>imbalance on the services ledger had continued to grow.
>
>Mr Ruthven said the only way to arrest the foreign debt problem was to
>lift the savings ratio which at the moment was a "disgraceful" five
>percent. This compares with 11 percent in Japan, 23 percent in
>Singapore and 31 percent in Taiwan.
>
>He said that Australia did have a savings ratio of 11 percent in 1975
>but 17 years of deterioration wiht governments, both federal and state,
>not balancing their budgets had whittled this down.
>
>Mr Ruthven said the government had been dodging the fundamental issue
>that Australia did not save enough to support the necessary
>infrastructure such as housing, roads and manufacturing
>infrastructure.
>
>...the foreign debt, now about $160 billion, was the second highest in
>the world, behind the US and predicted it could pass the $200 billion mark
>by December 1994.
>
>...the government should either scrap negative gearing and dividend
>imputation, both of which encourage borrowings, or stop taxing the interest 
>on savings.
>
>
>Disclaimer : The above is obviously not the view of my employer, its a quote
>of somebody else yacking. So its not really my view either.
>
>
>What do I think? I'd like to see some money channelled out of real estate and
>invested in my kids' future. I'd like to see the family home taxed as an
>asset, and negative gearing abolished. Also I'd like to see death duties 
>introduced and the funds channelled into an investment bank for new Australian
>companies.

The problem with negative gearing is that the lobby groups are too strong to
allow any changes to it.  So the Governemnt's only available choice for
controlling unproductive negative gearing is to keep inflation low (at the
risk, no, certainty, of producing prolonged recessions).  We can see the effect
of inflation on the value of negative gearing by looking at the inequalities
that tell us when negative gearing is worthwhile.

A simple analysis shows that negative gearing is worthwhile if the inflation
rate, f, obeys:

f > (i-r) * (1-t)

where i is the borrowing interest rate,
      r is the rate of return of the investment
      t is the taxpayer's marginal tax rate

So for example if i is 11%, r is 6% (rental property) and t is 48.5% then
negative gearing would be worthwhile if the inflation rate (on the property's
value, specifically) was greater than 2.6%.  So to prevent this wasteful
negative gearing starting up again, the Government has to keep inflation below
2.6%.

I say "wasteful negative gearing" because if the inflation rate is 2.6% then
the real interest rate in the above example is 11% - 2.6% = 8.4% which is
greater than the rate of return of the investment (6%).  This means that
because of the negative gearing tax laws, a person is encouraged to borrow at a
higher real interest rate than the rate of return on his investment thus making
a real loss.  The tax office thus causes loss making investments to occur, with
the tax office paying the loss.

The overall effect is that (during times of sufficient inflation) there were
massive amounts of investments that were making a real loss that was paid for
by the tax office (or more precisely, genuine taxpayers such as PAYE
taxpayers).

In conclusion, the macro-economic management of this country (courtesy of the
Treasury) is fundamentally incompetent.  One of the fundamental requirements of
the tax system is that it should not distort investment decisions (i.e. it
should not make an investment viable if it was unviable in the absence of
taxation).  The Treasury made no direct effort to change this situation.  Its
only effort was to cause a recession that brought down inflation as an
after-effect.

Chris O'Neill
Telecom Research Labs
Newsgroups: aus.politics