Reteaching economics in practice

Reforming economics teaching has been a heated topic of debate since the financial crisis. My personal views on this align closely with The University of Manchester’s Post Crash Economics Society (PCES), who have been calling for a pluralist approach that would rid economics teaching of its neoclassical core, and replace it with a critical study of economic questions and the diverse methods and approaches being taken to understand and answer those questions. The group Reteaching Economics has similar aims. Certainly a focus on empirical methods would be elevated to a core element, as the question of how can we know things is a primary concern to critical analysis. In all such an approach is not an excuse to avoid mathematics, but to embrace a the wide range of mathematical tools in use.

Change like this is a difficult task, and will ask a lot of students and teachers alike. But in my view it is also a difficult task to teach and learn the bland, abstract and often irrelevant economics that fills the undergraduate textbooks today. Even very complex concepts can be reduced into small components with memorable analogies that make them digestible. And if done right, a new approach should trigger more of a desire in students to learn and apply these new concepts and tools.

I have tried to shift my own teaching towards this approach. The purpose of this post is to share an example of taking an existing course, and the various constraints that came with it, and shifting it towards a more critical and pluralist teaching approach.

Last year I taught Managerial Economics and The University of Queensland. The student body were not all economics majors, but were drawn from across the university’s disciplines.

One constraint was the prescribed textbook (which I could not change by the time I began teaching). It contained repeated lessons in applying optimal control problems willy-nilly to possible problems that might face a firm manager. Like how should I profit-maximise when I have two goods that are substitutes?

Solving an equation that relies on knowing the cross-price elasticity between your products is actually not very useful. The important questions are much deeper and more critical, like “How do I know the own-price and cross-price elasticities in real life?” I mean, are firms really just changing prices all the time to check on their elasticities? Or “What is the current price and why was it set at this level?”

So what did I change in the course?

I made sure that before they embarked on the “textbook” concepts that they were given a broader outline of the big ideas that are implicit in the textbook view, yet completely hidden. Like “What do prices do?” And, “If prices allocate resources, why do firms exist?” You can download my first week’s notes here (I make lecture notes a seperate reference document and use lecture slides as a tool to build and explore example problems during class). To see my emphasis on providing a pluralist view, this is one of the exam questions I snuck in.

Which is the most accurate comment on the following statement - “Firms maximise profits”?
A. Always, because by definition they are profit maximisers.
B. Never, as profits do not always accurately reflect long run payoffs.
C. Often, and always in preference to potentially conflicting objectives.
D. Sometimes, but they may achieve this through intermediate objectives.

I also cut short many weeks of textbook regurgitation and replaced it with concepts and tools that don’t fit in the paradigm, but are nevertheless quite useful in practice. For example, I introduced a simple analysis of real options in investment decisions, which captures many of the realities of irreversible firm decisions (here). I also included a week on networks and evolution that introduced some simple models to capture some of the more interesting firm and market dynamics (here), and allowed us to have informed discussions on questions like performance pay for individuals or teams, and revisit the reasons firms exist at all. When I cover information problems, I discuss adverse selection, but also beneficial selection, and look at how the data shows the opposite of what the textbooks predict in Australian health insurance markets.

I also changed the assessment items from almost purely multiple choice and short answer exams, to a mix of some multiple choice, short and long answer questions that allow concepts to be applied to real life situations and data, and an assignment.

The assignment was about a real company facing real changing market conditions. Students were expected to determine the relevant data they needed to collect to complete the parts of the assignment, then find it, then use it (run appropriate regressions), then interpret it, and present it all in a professional way. Some of them told me it was the best assignment they had done in their whole course in terms of actually learning something interesting, and producing something they can be proud of. This was a relief. I had spent a lot of time preparing it.

Some of the economics majors said it was the only assignment they had ever been asked to do! This was quite worrying, but completely in consistent with economics courses globally. The PCES survey showed that a fifth of economics subject have multiple choice questions make up more than 90% of the course grade, and in half of subjects they make up over 50% of the grade. As a general rule, economists are trained to solve equations and answer multiple choice questions.

So what is stopping these changes from happening across the board?

First, few academics maintain the connection with the wider business and public policy community to have a ready supply of topical recent examples where economics can be applied. They are so narrow in their research focus, that when teaching outside this area, they simply conform to the standard textbook.

Second, many academics are trained neoclassical economists only. When my exam draft was reviewed by another academic for errors, they noted that they had never heard of real options, nor the evolutionary and network models in my course. This becomes an even more serious problem in courses where completely wrong models still fill the textbooks, such as the case with the money multiplier. I have had to stand up in class and say “Ignore chapter 19 of the textbook, it is simply wrong.” Some economists are too loyal and “profession proud” to say something like that.

Third, it is a lot of work for staff. For my teaching last year I spent about 18 hours preparing each lecture. This meant that I had new examples to use, new data, and updated readings that applied economic ideas to recent events. For the assignment I also had to research and write my own version of the assignment to make sure I was asking something that was possible to do, and that the data would reveal something that wasn't apparent on the surface (in this case that a firm which is often thought of as being "high end" actually sold inferior goods). When you want to have students research relevant recent real-life examples, this is what you have to do.

Fourth, some students prefer to just get the grade and don't like the ambiguity that a more pluralist approach entails. They have learnt how to study for multiple choice exams, how to solve equations, and so forth. Having to actually think, while being uncertain about how your thinking will go in the assessment, becomes a challenge.

I’d be interested to hear how others have gone about improving their economics teaching to be more critical and pluralist, and what constraints they faced.

Land tax becomes respectable part of tax debate

After decades of political pressure that systematically clawed back state and local government’s ability to tax land, the debate has now swung back to this most efficient of taxes.

Land taxes are apparently a hot topic for debate at the years NSW Labor annual conference.

New sweet-talking Prime Minister Malcolm Turnbull even said the formerly unspeakable words on national television over the weekend (at the 6.30minute minute mark). Though he says while it is a great policy economically, it is politically 11 out of 10 in terms of difficulty. No $hit. When your voter based is dominated by homeowners, and your party made up of the country’s wealthiest landowners, you ain’t got a chance.

Let’s do the hypothetical anyway. How much could be raised from state land taxes?

In NSW just the exemptions to the current 1.6% (2% over 2.5million in value) land tax amount to $700million per year.

In Queensland the exemptions to the current land tax regime cost the state $1.3billion in 2014-15, with the components of the costs of the exemptions summarised in the below image.

Yes, you will see a $23million per year land developers concession - at tax with the exact opposite incentives to efficient tax, reducing the cost of not developing land.

In Victoria land tax concessions are forecast to cost $2.9biliion in the current financial year, amongst a bunch of other concessions that amounted to a total of $4.9billion. See the summary from the budget papers below.

So just in these three east coast states we have about $5billion per year just in land tax exemptions, plus many billions in other exemptions, including on gambling. If we remove the land tax concessions and double the land tax rate to around 4%, these three states could raise another $13billion every year.

But that is just the start of the tax concessions for the nation’s wealthiest.

What about another tax loophole? The capital gains tax exemptions. Treasury estimates it costs the country $56billion per year.

Or discounted taxation on super contributions? There’s another $27billion per year.

There are simply billions lying on the table in obvious tax loopholes for the rich, with land tax exemptions just one of many.

We have seen one big change - saying the words land tax has become acceptable for a politician. Now let’s hope this change starts snowballing, and that states can fight the propaganda of vested interests to use their tax powers more wisely and efficiently.

Die solar roads. Just die.

Humans are quite smart for hairless apes. But sometimes I wonder whether we really do have the edge over our distant cousins.

Here’s an example. Solar roads. For some reason, the most idiotic idea ever still seems to gain popular attention and funding. France is now committing to investment in solar roads.

But, you are thinking, that actually does sound quite interesting and potentially wonderful. Oh, how innovative.

I know right? The urge to jump on board this idea seems irresistible. But that’s our monkey brain doing the thinking. Because when you switch on your rational mind the whole this looks like a big joke.

Our instincts are not good at thinking about a new idea in relation to a particular alternative. It takes conscious rational thinking to realise that for this to be a good idea, we need to think of alternatives to compare it to. Our default is to compare solar roads to no solar investment, hence the urge to think it sounds great.

So here’s an alternative. Solar panels anywhere but roads!

The solar roads concept also implies it is solving a problem that doesn’t exist. In this case, a problem of insufficient space for solar panels. But that is absolutely not a problem. Estimates suggest there are 400sqkms of just residential roofs space in Australia that could accommodate solar panels. More than enough to our total electricity needs, and that ignores the large industrial and commercial spaces available.

Here’s my very brief list of why the idea is stupid.

1. Roads have things on them that block the sun, like cars, people, trees and buildings shading them and so forth. 
2. Roads cannot be angled to efficiently capture sunlight. 
3. Roads get dirty. 
4. Roads need a superstructure above the solar panel that will reduce efficiency. 
5. Building solar roads means expensive excavations and repairs that will block traffic flow. 
6. The technology to do it is rubbish. 

You may have heard that in Amsterdam there is a trial of a solar bike path. I think the title of this article sums up their result “That Fancy New Solar Bike Path In Amsterdam Is Utter Bullshit"

That article says it all.

What about a better alternative? How about building a roof over bikeways covered in solar? This alternative has a few things going for it

1. No excavation 
2. Cheaper 
3. Keeps cyclists dry 
4. Keeps snow off the bike path in cold climates
5. Can be angled to the sun 
6. Is proven technology 
7. Provides shade in hot climates 

Plus more.

And, it has been done before quite successfully.

So please, turn off your monkey brain. And when your friends on social media get excited about solar roads, send them here. Or send them this.

How to get your land rezoned: A QLD story

My previous research looked at favouritism in land rezoning via the Urban Land Development Authority (ULDA) in Queensland. By looking at the characteristics of landowners inside and outside the boundaries of the rezoned areas I was able to show that that main determinant of getting rezoned is not your land's size, or location, or any other planning consideration, but how well-connected the landowner is in a social network of connected elites in Queensland.

So it is interesting to see one of those landowners who missed out (partly) on the favouritism of the ULDA seeking favours from the Logan City Council using exactly the type of textbook methods of influence I uncovered in my previous research.

The project is called Flinders, and it is situated outside the southern boundary of the Greater Flagstone ULDA area (which after a change of government is called a Priority Development Area). When I came across materials for this development proposal I thought it quite unusual; it’s not in a priority area, there are plenty of identical “new town centre” developments planned within a 10km radius, and there seems to be quite a lot of marketing fluff online considering the thing isn’t even approved and probably shouldn’t be according to existing planning controls.

For someone who has spent four years investigating dodgy planning approvals in this area it was a case that seemed quite interesting.

In the image below, from the documents submitted for planning approval, you can see the priority development area (GFPDA) hashed on the right of the blue line. The land owned by Pacific Holding Pty Ltd (applying for the development approval) is in yellow, and they are seeking to approve a massive new township on this whole area (which is currently agricultural). If you want to look up all the details go to the Logan Planning and Development Enquiries page (here), and search for application MCUI - 38 / 2015. It applies to Lots 1, 2, 3, 19, 32, 42, 79, 80, 390 and number 194 Mount Elliot Road, Undullah.

The proponents state in their application that they missed out in being fully within Greater Flagstone Priority Development Area (GFPDA), and are arguing that they should be treated in a similar manner in terms of planning outcomes. They say

The subject part of the Flinders development will provide a logical extension to the GFPDA and will be a key landholding contributing to land supply to accommodate forecast growth in the region. Ultimately it is anticipated that the population of Flinders will be in the order of 50,000 people (32,000 of those will reside on the subject site) with 15,000 permanent jobs created in a range of occupations.

Note the ambit claims of future population. Sure, maybe at some point this century there will be 50,000 people there. But not in the next couple of decades. It’s also lovely to see claims of how well-connected the site is. I drove through there recently. Trust me. It’s not well connected.

In any case there are some more interesting parts of the application which show a textbook effort in gaining political favour, after having missed out on the last round of favours at the ULDA.

Who is this?
Darwin and Michelle King are the children of Philip Cea, a fruit grower who was embroiled in the citrus canker outbreak in 2005, and was claimed to have bypassed quarantine to import fruit trees and vines in 2001. Aside from the fruit business, he has also has built relationships with government, and was part of a 2013 trade mission to China along with a number of other high profile property industry people, including professional lobbyists (some being former politicians), many land developers, and real estate agents.

The relationship building
I found this video of the King’s hosting a one-day development forum about Cities of the Future, which provides a picture of the next generation’s own efforts to build relationships. Invited were various State agencies and local government representatives, planning consultants and property industry organisations. It’s quite interesting to see their investment in relationship-building documented this way.

It’s almost as if the development cannot be justified through regular planning routes based on its own merit.

Some of the names of consultants employed or appearing in the video include, Mike Day from RobertsDay planning consultants, Gavin Johnson and John Harrison from Mortons Urban Solutions. Daniel Parker and Alexander O’Reilly from MacroPlan for the “needs assessment”. Stephen Harrison from iLiv group, who is also Vice President of the industry lobby group the Urban Development Institute of Australia (Qld), is the project director for the Flinders development.

I'm not accusing any of these people of doing anything other than what they are employed to do. But hiring the "right" consultants has always been part of relationship-building, something the King’s have been undertaking with vigour in order to secure their planning approval. Does anyone really think they would have the same chance of success if they only hired consultants who had never dealt with the local council or State government before?

The cover fire of urgent demand
The “Housing and Non-Residential Needs Assessment” submitted as part of their application is quite something. It asserts that when there are 50,000 people living there, than there will be demand for many services and facilities. I’m stunned. But I don’t see anything about where the 50,000 number comes from.

They also try to hitch a ride on the back of the neighbouring Priority Development Area again, this time by stating how much their development will “amplify” all the gains. It’s a real magic pudding story devoid of any realism.

But we know this is all nonsense. Another Priority Development Area, Yarrabilba, which is a very similar urban fringe development, has a 30 year timeframe for their build out to 45,000 residents. With both of these substitute developments competing for buyers and new residents, I expect that it will take half a century or more to get close to building what is proposed.

To be more clear, population growth in the whole of Queensland was 70,540 people in the year to June 2014. What share of Queensland population growth will go to this one development each year? Maybe a percent? So at 700 people per year, that's 71years to build out the development.

So why the urgency? What exactly is the pressing need? Is this just cover fire - a distraction for the public and an legitimate-looking excuse for the council to approve what might otherwise be a nonsense application?

The lies?

On page 44 of their application they commit to

Develop an Innovation Precinct in partnership with Massachusetts Institute of Technology (MIT) and CSIRO.

They also reiterate this on their “Housing and Non-Residential Needs Assessment”, stating

Flinders was a core partner (along with CSIRO) in a submission to the Australian Government earlier this year seeking to establish an Industry Innovation Precinct focused on urban development. Its goal was to provide the opportunity to integrate innovation into existing urban development practices that could create an exemplar sustainable community and be replicated nationwide. It is not apparent whether this program will continue under the LNP, however Pacific International Group has secured Massachusetts Institute of Technology (MIT) and Bond University as innovation partners to build on the work done to date. This may also include a tertiary education facility.

They go on to explain the value of having an MIT facility in the area. That would be quite something. My guess is that they are talking up “inviting someone from MIT to a conference” as some kind of commitment to a remote campus. Again, if the demand for this development exists there, why the need to name drop so outrageously?

Trusts and hiding financial interests
It is common to use trusts and other structures to hide what is going on. Flinders is no exception. Here it’s the Pacific International Development Corporation (PIDC) Trust making the application. The land is owned by Flinders Land Holding Pty Ltd.

As it typical in Australia, knowing exactly who owns what land is often quite tricky. After years of being unable to truly enforce our own tax laws, the Australian Tax Office has now requested from each state 32 years of land ownership records. It remains truly bizarre that land titles and corporate records are not freely available online. Knowing who's who is a business for insiders only.

Weakness of political donations
What I didn’t find is also notable. I didn’t find any records of the Kings, or their various businesses, donating to State politics in the last few years. This is one of the findings I made when studying rezoning in other ULDA areas. Political donations weren’t as useful at gaining favours as being well-connected to insiders.

If my research has merit, and if the King’s continue to build their relationships with property insiders, than I have no doubt they will be granted extremely valuable rezoning gifts soon enough. If only they had been working their relationships this much back in 2005-2008 they might have had their whole property declared inside the Greater Flagstone ULDA (now GFPDA) the first time. 

#ResistCapitalism

My twitter feed has been aroused into fierce anti-capitalist protest. Welcome to 2016 I guess.

This situation gives me chance to flesh out some important points that cannot be made effectively on Twitter.

Resisting power
My view is that the hashtag has arisen out of a resistance not to the capitalist idea of private property ownership in particular, but the exercise of political power under the veil of capitalist ideology (much like the Occupy movement). Bailouts of banks not for people. Money for weapons and war but not public services. Increasing legal protections for the rent-seeking elites, such as extending patent and copyright protections. Removal of the power for workers to organise in their interests. A hollowing out of welfare based on ideology, rather than an extension of it based on our accumulating wealth abel to shared.

But these types of power conflicts arise in all systems eventually. So while the protest is brought together by a common enemy of the current system, many involved have vastly different ideas about what alternative system would better deliver their desired outcomes.

Sclerosis
Mancur Olson spent a career making the point that stable systems begin to break down over time due to infighting over economic rents. That is what we are seeing now, to an elevated extent, in many of the major Western economies. What sort of system do we have that allows the rich to become so insanely wealthy while leaving others poor, homeless, and struggling for find a productive social niche for themselves? The answer is a system suffering from heated internal infighting. My view is that this occurs after a period of stability and a lack of external threats to the existence of the group (i.e. country). You see after a war that it suddenly become easy to distribute wealth to returned soldiers and their families, providing cash allowances, public healthcare and housing. Yet when the war is amongst internal interests, these desirable institutions suffer.

An ecosystem of institutions
What most people want is a set of institutions that allows for private investment and risk taking while ensuring the negative external effects of these activities are limited. They want stable basic services provided in a manner that ensures equitable access, rather than access based on wealth and income. These basic services will obviously expand as nations become wealthier and luxuries become necessities for functioning in the modern world.

Another thing is that some kind of welfare state is essential for maintaining the dynamism of the capitalist part of the economy. Without this cushion against failure, who would risk their life savings on inventing and investing in new products and innovations? Essentially we all want a mixed economy, a level of safety net that reflects the wealth of the country, and basic services provided in an equitable manner. It sounds a lot like the basic economics. Go #MixedEconomy! The main argument is around which institutions can deliver this effectively, given the realities of politics.

The role of economics

Strangely enough, the core of mainstream economic theory assumes that these desirable systems of institutions have already been met. Even more strongly, models that deal with a “representative agent” assume that a government agency is constantly redistributing wealth in the background so that all people are equally wealthy. This then allows the nice results in terms of efficiency to not have implications on equality.

Let me quote from the world’s most popular advanced microeconomics textbook.

The idea behind a social welfare function is that it accurately expresses society’s judgments of how individual utilities have to be compared to produce an ordering of possible social outcomes.
…
Let us now hypothesise that there is a process, a benevolent central authority perhaps, that, for any given prices p, and aggregate wealth level w, redistributes wealth in order to maximise social welfare. (MWG p71)

So why aren’t all economists raging with the Occupy protestors? Or arguing for a massive redistribution of wealth as an immediate first step to social improvement? Has the discipline sold out to the highest bidder? My view is that economists need to stand up and point the finger at sellouts as a first step in cleaning out this unusually influential discipline, and hopefully in the cleanup process ensure that economic advice arriving at the political level does not suffer from conflicts of interest.

Back to access to political power

Such protests boil down to the inability for the vast majority of people to get a fair say in democratic processes. Obviously bailing out private banks is not capitalism. Severely unequal trade agreements are not capitalism. The Wests selective involvement in destroying “democratising” countries with oil, while ignoring atrocities elsewhere in the world. The inability to invest in public goods in the face of ideological push back by vested interests. They're not capitalism. Occupy Wall Street had similar motives against entrenched interests.

A mixed economy, with a fair share of “capitalist” private ownership of property is a great thing. But when the political power of a select few capitalists overwhelms the system to the extent that the other non-capitalist parts of the mixed economic suffer, there are obvious and genuinely satisfying moral grounds for protest.

Minor tweaks

So what simple changes could #ResistCapitalism argue for? Here are some

• Annual taxes on wealth 
• Taxes on inheritance 
• More proportional representation in government 
• An independent watchdog seeking out conflicts of interest in politics and business
• Public investments based on local need, and as a way to support local labour demand

Temporary fixes
Any system will start being gamed as soon as it’s created. We need the general public to continue to be politically active and organised, protesting about particular single policy ideas that could be implemented should the movement gain momentum. Be clear that replacing capitalism does not automatically mean replacing the tendency towards plutocracy or oligarchy.

Still more unpopular economic opinions

I have two recent popular posts on my unpopular economic opinions (here, and here). Over the Christmas break I spent time reading and thinking. Here are some more opinions.

1. Democracy is not part of the recipe for a nation’s success. The historical evidence is pretty overwhelming here. Democracy can be useful to appease competing internal interest AFTER overall stability of the legal and economic system is obtained. Introducing democracy BEFORE this generation-long period of stability is a recipe for instability because there is no reason to trust the ballot box.

We also forget that the word democracy captures a vast array of different political institutions. There is no ‘one democracy’. Indigenous Australia’s could not vote in Queensland until 1965. Women in 1905. The voting age was lowered from 21 to 18 in 1973. Making voting compulsory came back in 1924. All of this democratisation happened after the country was quite politically stable. Not before. This is the empirical trend. The Asian Tigers weren't known as the democratic Tigers.

UPDATE: Yanis Varoukafis makes similar points and more in his TED Talk here.

2. The economics blogosphere reveals that economics is often just a clash over competing metaphysical explanations for a phenomenon. “No it’s not secular stagnation, it’s a savings glut”. For an outsider, it might seem intelligent. But in reality, it is chest-beating about preferred ways to label the residual.

3. Improving economics is not about the mainstream versus the rest. It’s about social scientists being able to communicate big ideas to each other, and about empirical strategies to try an eliminate bad or useless ideas and refine the domains in which particular models may apply. Read Evonomics.

4. The long peace since WWII is a historical anomaly. Expect either a) another war between superpowers in your lifetime, or b) a perpetual skirmish against nominal out-group "enemies" who are mostly fabrications.

5. There is no ‘willing driver shortage’ in our car-based transport system. Robot car driving is not in demand. Also, any economic benefits of replacing the labour of a car driver are even greater for rail and bus transport. Driverless cars do not rescue car-based urban transport from its inherently bad economics. Even Uber is using ‘smart routes’ that look like mini-bus routes.

6. Robots are not coming for our jobs. Why is this a thing? Even if robots are intelligent, they will just be a really advanced tool. Like a modern slave. The owners of robots would see advantages. But if they are so smart, wouldn’t they take over the role of capitalist rather than worker to make the big bucks? Or is it all just nonsense. After all, a monkey can’t own the copyright on their own photo, so I’m sure a robot can’t. Nor can it own the product of its own “labour”. To me the robot commentary it is all made up nonsense that ignores the history of mechanisation and the rise of services.

7. Ageing is bloody brilliant. There is nothing good or bad about population growth. It just is. But a stable population makes per capita economic gains much easier, reduces conflicts over resources and so forth. What makes ageing "bad" in some economic analysis is that we seem to pretend that at arbitrary birthdays people in society go from productive contributors to leaching resources. It’s not so simple.

And seriously, if non-workers we such a major economic problem, we would eliminate private ownership of capital anyway. We can't let those capital owners make an income without working, can we? They would be economically costly, just like old people. 

The bizarre politics of child care policy

The latest news doing the rounds is a “crackdown” on childcare rorting to the tune of $7.7million a week (about $400million a year).

Ah yes, cracking down on the really important big items. Put that corporate tax avoidance to one side. Save the crackdown on political expenses for another day. The big news is here.

Unfortunately the logic at play in this childcare crackdown is absurd.

To consider what is going on we first need to understand that in Australia we have a system of childcare subsidies designed to get mothers into the formal workforce. Yet, with carer to child ratios mandated at 1:6 on average for non-school age children, we should expect that a fair proportion of these working Mums trade home-making for childcare work in order simply to make up the numbers.

If the average additional mother entering the workforce as a result of childcare subsidies has two children, then each additional women entering the workforce has about a one third chance of working in childcare. Essentially the policy requires that for every three Mums entering the workforce there must be one child care worker, giving a net gain in the non-childcare workforce of 2 out of 3.

What this “crackdown” is designed to target is Mums running what are called Family Day Care centres, where they care formally for their quota of 6 children in their own home. Obviously their home must meet various size and safety standards and so forth.

The “loophole” is one where

“… parents who run a family day care receive childcare payments for having their own child in a different day care service at the same time.”

But what is exactly wrong with this? If we go from a world of no formal day care, to one with formal day care at the 1:6 ratio, than we should expect that a third of Mums entering the workforce work in childcare. And their children will also go to childcare so that Mum can work.

Do we hear complaints that staff at formal day child care centres whose children are in care at other formal centres are “rorting the system”? So simply changing the location from “non-house” to “house” means the system is somehow not working as designed.

That’s bogus. The system is designed expressly for this to happen. It was clear and obvious to anyone who has thought about it for five seconds.

This is what happens when you create policy designed to juice the economic statistics by making the informal economy formal.

Meanwhile, the government is expanding child care subsidies to nannies this year with a pilot program covering 10,000 children. For the life of me I can’t understand what the difference is between this and the family day care “rort”. Should we expect that older siblings or cousins becoming nannies all of a sudden. Probably. But what would be wrong with that exactly? The economic effect is exactly as desired.

Most popular posts of 2015

Blog posts were not as frequent as I would have liked this year. But I did gain a much wider audience with some of the more popular posts that were widely cited. I'm proud of them. I hope my readers found some valuable insights in there somewhere. 

If you want to indulge your economic curiosity over the holiday period, here are the top ten posts of the year for your reading pleasure.

1. Improving 'Neoclassical man' with a gaze heuristic

2. Macroeconomics = Fallacy of Composition

3. Back-scratching: Do what's best for your mates and screw the rest

4. Adam Smith’s Pin Factory: Capital vs division of labour

5. The confused economic orthodoxy

6. Uncertainty and morality in a dynamic economics

7. More unpopular economic opinions

8. Unpopular economic opinions

9. Dodgy rezoning, a summary

10. How to analyse housing markets

Humans vs Houses: Australia's perverse tax system

Investment property income beats working
I often joke that my investment property earns more than I do. Thinking more about this led me to the realisation that my investment property has an privileged position in the tax system when compared to a measly old human.

Below I summarise some of the main tax considerations from the perspective of being a human making wages, or from the perspective of being an investment property (the property owner).

After making this comparison, our current system appears to be designed exclusively for the betterment of the property community, rather than the people community. It’s unreal. The whole thing is back to front, with all that green showing investment property to be a clear tax winner.

Let us take a closer look at the marginal effects of a dollar increase in income for a one-income family, with two school-age children earning $100,000. They are an above-median household, and a prime candidate property investor. You know. To secure the children’s future. We’ll call them the ‘Battler’ family, because in Australia if you aren’t on the property ladder, making money is a battle.

An extra dollar in wage income for the Battler family over a year attracts income tax, along with a loss of family tax and medicare benefits that together account for 60c of that extra dollar. So 40c in the pocket. The graph below, from David Plunkett, shows the effective marginal tax rates (EMTR) for this family currently in Australia.

Let us examine the case when the Battler family instead makes their extra dollar from capital gains on their investment property. Using round numbers, they buy a $500,000 home with an annual rental income of $20,000, and annual rates, maintenance and other costs of $6,000. They finance this purchase with an interest only loan attracting a $25,000 annual interest bill.

They make a loss of $11,000 over the year they own the property. Of that loss they are out of pocket only $4,400, because they have reduced their taxable income and avoided $4,000 in tax, and gained $2,200 in family tax and medicare benefits.

After one year they sell with a price after selling costs of $511,001, making $1 net over the year from the property investment project.

It’s a risky way to make $1, compared to getting a rounding-error sized pay rise. But we want to compare dollar-for-dollar the tax incentives for earning wages or earning capital gains though property speculation.

So what did the battlers get out of their $1 gain from property investment? First we factor in the 50% capital gains tax discount because they owned the property for more than a year. So they only need add $6,500.50 of the capital gains to their taxable income. With a 60% EMTR that means they keep $9,100.20 in the hand (the tax-free $6,500.50 half, plus 40% of the remaining $6,500.50).

Subtracting last year’s net loss of $4,400 gives a total net gain of $4,700.20. I summarise how this arises from the benefits tax treatment of both the losses and the gains from investment property in the table below.

With these types of advantages to making your money from lazy capital gains on investment property, rather than working for a living, it is no surprise that we have become a nation of property speculators.

We can also work backwards to see in this example case how much of a loss on property the advantageous tax treatment will cover. To break even after tax all the Battler family need to do is make $4,400 after tax on the sale, which would be situation if the capital gains were $6,286, or a sale price after selling costs of $506,286. Under this situation the property investment has made a loss of $4,714 over the year (an $11,000 income loss and a $6,286 capital gain after 12 months), yet the tax system has bailed out that loss for the family through negative gearing and the capital gains tax exemption. Add another 57c or so to the project income - so it makes a $4,713.43 loss - and you are back to the same net outcome as making an extra dollar through wage income; a 40c gain.

Policy for an even playing field
We can use this example to also see the immediate impact from tax policy changes targeting investment property. If we eliminate the capital gains tax discount and quarantine losses against property incomes, we get a different story, which is in the table below.

Here the $11,000 loss rolls over to be deducted from the future income of the property, in this case the capital gains on sale, making the net capital gain of $1. Because none of this gain is subject to the CGT discount, it all adds to personal income and is taxed at the marginal rate, along with the losses in other welfare benefits. After tax both the $1 from investment property and the $1 from the wage income now provide the same benefit.

It is certainly now time for the government to end these tax concessions for investment property. Raising the GST, the current government’s preferred tax policy, is probably the worst choice in terms of both equity and efficiency compared to the low-hating fruit of removing these property tax advantages which currently cost the budget about $11billion a year. Obviously removing them would change incentives, reduce prices, and so forth, meaning that actual budget gains from their removal will be lower. But even so, the shift of incentives across the economy would be hugely advantageous in terms of both efficiency, and equity, as these tax incentives primarily benefit the wealthy.

Update:
Because many claim that negative gearing is a ‘natural result of the tax system’*, we can leave this alone and simply concentrate on the capital gains tax discount.

In this case, the table below shows how the tax benefits from negative gearing remain, yet the capital gains taxes completely offset the tax benefits from the losses made, resulting in the same net outcome. What this means essentially is that this small part of the tax code provides very perverse incentives for investors to speculate on property, than to earn income from wages.

* To the extent that any tax system is ‘natural’. My view is that you use the system to create incentives for productive activity, whether they appear natural or not.

Brisbane's Queens Wharf is a gift to casino owners

Let's bet on when the consortium entering a deal to build a new casino in Brisbane will go bust.

I will bet straight after the company has paid their well-connected senior staff handsome bonuses, and right before being bailed out (probably implicitly) by the Queensland government. As the project progresses the government will bail out the consortium either voluntarily, because the Ministers and staff involved want to build trust with the consortium, or under duress, because the consortium is going bankrupt with a half-finished major project in the CBD.  

The bailout could be in the form of cash payments. But it could also be hidden in the form of an amended scope of works. Promised investment in new public spaces around the casino will mysteriously shrink as the consortium pleas that these were never part of the deal to be delivered by them. The government will be on the hook for hundreds of millions of dollars right at a time when the budget will be drying up from the downturn of the resources and property boom.

I make this bet because I have looked that the fancy images produced to sell the project to the public, and drawing on my experience in costing large construction projects, I can assure you that adding the costs of all the public works in these images cannot be justified by the casino and hotel returns alone. It just doesn't stack up.

This quote worries me 

The Queensland Government in partnership with the Destination Brisbane Consortium will deliver… 

Public-private partnerships. Notice they didn't say those words explicitly. Because they are dirty words these days as we have come to realise that the public sector simply does not have the skills or the courage to be an equal partner. Such partnerships these days mean that all risk passes to the State while all benefits flow to the private sector partner. 

I remember sitting in a meeting with Queensland Treasury in 2009 where they were trying to get rid of these arrangements from government because they always end up tilting risk towards the government and benefits towards the private sector partners. 

But no worries. Happy to do it for a casino.

If you look at the picture below it’s almost like the government wants to get a casino as close as possible to their offices; to align themselves through proximity to the interests of the casino owners. 

I can’t think of a better way to hand money from the public to selected rich, politically-connected casino owners than this. 

For those still thinking about all the external benefits from a new casino (which is adjacent to an existing casino mind you) maybe think a little harder about the international market for high-rollers. You’ve got all of Asia to choose from. The major cities of the world. Will Brisbane now all of a sudden pop onto your radar because there is a new casino next door to the old one? A very marginal proposition at best.

Crucially, watch as the funding mechanism to capture the value uplift on the site is ignored. Gains in land value will be given away to the consortium from the inevitable government investment in public spaces and access to the area.

This will happen because the rules about paying for infrastructure are especially grey in the case of such major projects (see here, Section 6.0)

Infrastructure delivered in the PDA shall generally be funded from infrastructure charges levied on development within the PDA.
Infrastructure charges will be based on Brisbane City Council's applicable infrastructure charging document for the area or an Infrastructure Agreement.
Infrastructure delivered as part of the development may be eligible for an offset against the infrastructure charges that would otherwise apply.

The last point here is important. What it means in practice is that there is plenty of scope to negotiate that publicly accessible spaces in the casino area count towards public infrastructure, and that these might even be used to offset the standard infrastructure charge obligations under the Brisbane City Council’s plan. We have seen wiggle room like this used successfully before to get out of obligations to contribute to the public realm, with private driveways and car parks being counted as public space contributions in complete contradiction to the planning intention of these requirements. 

Essentially, the government is walking into a deal taking on a huge amount of downside risk and absolutely none of the upside. It is guaranteeing profits to wealthy casino owners in a way that is primarily a transfer to them from the rest of society. This is at a time when government revenues will begin falling, and when the city is already committing to costly projects with little to no return, such as the Kingsford Smith Drive project, where costs are likely to exceed benefits by about $200million.

But it remains possible that when the reality of the construction costs becomes apparent, the whole project might simply be canned come late 2016. 

I have no problem with government investing in public infrastructure and improvements in general, but not with the obvious intention of benefiting a select few at a cost to the rest of us. There are so many public projects out there with high benefit cost ratios waiting to be built in the city, from rail, cycle, pedestrian upgrades to improve connectivity, to the basics like stormwater and flood prevention upgrades, and so forth.

Read all about the agreement here.

UPDATE: Read all about the dodgy dealings at the blog It's Not Normal