To believe that Mr Calombaris would open his restaurants on Sundays only to have them run at a loss is to believe that he’s running some sort of altruistic quasi-charity, an impression he attempts to give by suggesting that he opens on Sundays for reasons of “tourism”. I don’t believe that a successful businessman like him would run at a loss out of the vague goodness of his heart. Alternatively, he might choose to run at a loss on Sundays in order to build brand loyalty and increase his custom on other days of the week; the total return to opening on Sundays would therefore presumably make it worth his while.

He claims that he “recently stumped up $45,000 for a pasta extruder for Mama Baba” but that labour costs are now threatening his ability to make a decent return on that investment. The obvious question is why he dropped $45k on a pasta extruder if he knew he wasn’t going to be able to use it at a profit. The current restaurant industry award has been in effect since 1 January 2010; he would’ve known full well at the time he made the investment what the minimum wages and penalty rates were in his industry.

Anyway, he also makes some assertions about minimum wages that are straight-up false. He says that waiters would have to be paid $40 per hour on Sundays. This isn’t true.

The highest minimum wage in the Restaurant Industry Award 2010 is for a Cook Grade 5, described in the award as as a:

chef de partie or equivalent who has completed an apprenticeship or has passed the appropriate trade test or who has the appropriate level of training in cooking.

To employ such a chef at the highest grade would cost Mr Calombaris $19.71 per hour for ordinary time, or $24.64/hour if the chef is a casual (and therefore not entitled to paid annual leave and sick leave). If they’re employed as a casual on a Sunday, they receive a minimum of $34.49 per hour. Calombaris claims that he has to pay his staff a 75% loading on Sundays, but this includes the 25% casual loading. Even a worker at the highest grade in the award would not be entitled to the $40/hour Sunday rate that Calombaris bemoans.

But Calombaris’ criticism is specifically directed towards the wages paid to waitstaff. Here he is even more off base. Waiters (‘food and beverage attendants’ in the language of the award) would typically be employed at Level 1, 2 or 3, depending on their skill, experience and range of duties. If they’re employed at level 3, their ordinary time minimum wage is $17.14, or $30 on a Sunday for a casual.

Minimum wages in the restaurant industry

Source: Restaurant Industry Award 2010

If Calombaris is paying any of his waitstaff $40/hour on Sundays he is paying at least 33% above the award. Good on him, but if he’s doing so then he can’t really claim that the award is the cause of his high labour costs.

Another of Calombaris’ claims is that Australian fine dining restaurants are more expensive than their overseas equivalents. He told The Power Index, as reported in Crikey, that:

I can eat at [UK three Michelin star restaurant] Fat Duck cheaper than I can at some fine dining restaurants in Australia. But I know why it’s like that … because of our labour laws.

This is a strange claim. The tasting menu at The Fat Duck is £180 per person (plus an ‘optional 12.5% service charge’). At the current exchange rate, that’s around $AU270, without the service charge. The best restaurant in Australia, Quay, charges $220 for its tasting menu. Mr Calombaris’ own flagship restaurant The Press Club, charges $135 for its somewhat ostentatiously titled ‘symposium degustation’ tasting menu.

Australian fine dining restaurants appear to be a fair bit cheaper than their overseas counterparts, if we use the Fat Duck as a yardstick (as Calombaris himself has done) and convert the prices using current exchange rates. A better way to compare the prices across countries is in terms of median wages – how much of a typical full time wage would a diner have to spend to purchase a tasting menu at each of these restaurants? Well, in the UK the median full time wage is £501. This means a typical full time worker would need to spend 36% of her pay packet to buy a tasting menu at the Fat Duck (without the service charge). The Australian median full-time wage is $1050 per week, so a tasting menu at Quay costs 21% of a typical pay packet. The Fat Duck is more expensive for English people (and also for us) than its counterparts in Australia. Of course, overseas restaurants seem a lot cheaper to Australians than they used to, but that’s due to the soaring exchange rate.

Stepping back from Calombaris, what about the restaurant industry more generally? It’s certainly true that a greater than average proportion of workers in restaurants are paid at the award (minimum) rate. 45% of workers in the accommodation and food services industry are award dependent, meaning they’re paid exactly according to the minimum conditions in the industry. Only 15.2% of workers across all industries are award dependent. This means that if a change to the award system really had made it less profitable to employ staff, we’d expect to see the impact of the change most severely in the accommodation and food services industry. If Mr Calombaris’ story was accurate and modern awards were strangling his industry, we’d expect to see the profitability of restaurants go down, and employment in food and beverage service go down. This hasn’t happened.

Profit to sales ratio in the Accommodation and Food Services industry

Source: ABS 5676.0, table 22

Gross operating profits in the industry represented 12% of total sales in the September 2011 quarter, the latest quarter for which the ABS has released data.This is a higher ratio than during most of the WorkChoices period. Since the Restaurant Industry Award came into effect on 1 January 2010, the profit to sales ratio in the industry has been around 10% to 12%, in line with its typical level for the past decade. If the modern award is damaging the industry, it’s not showing up here.

You’d think that if the modern award had made food and beverage workers too expensive to profitably employ, then employment in that industry would fall, or at least grow more slowly than total employment across all industries. That hasn’t happened. Since November 2009, the last quarter before the Restaurant Industry Award took effect, total employment in food and beverage services has risen by 4%. Employment across all industries has also risen by 4%. The Restaurant Industry Award doesn’t seem to be damaging employment in that industry. Note that the employment data let us get down to the industry sub-division level, rather than just the overall industry level like the profits data above.

Employment in the Food and Beverage Service industry sub-division and in all industries (Index)

Source: ABS 6291.0.55.003, table 6.

Employment fell a little in the highly cyclical restaurants sector in 2011, but total growth since the new award system came into place has been the same as for the economy as a whole. If you’re going to blame the modern award system for the industry’s sluggish employment performance in 2011 then you also have to credit it with the surge that began in mid-2010.

At this point some conservatives might claim that total employment growth has been sluggish since the modern awards came into effect, so the effect is spread across all industries and therefore doesn’t show up in a comparison like the one in the chart above. If that were the case, wouldn’t the employment growth slowdown still be more severe in food and beverage services, an industry with a high proportion of award-reliant workers? The story just doesn’t hold up.

George Calombaris would like to pay his staff less money. He is entitled to make his case, but I wish his claims were subjected to a bit more critical scrutiny.

These were my most viewed posts this year:

• What is the typical Australian’s income?
• Inequality and the top 1% in Australia
• The state of the labour market
• Why care about inequality?

Thank you for reading!

• From the mid-1980s to the late-2000s, the incomes of the top decile of Australian households grew by an average of 4.5% per year, by far the fastest income growth enjoyed by high income earners in any OECD country. The average annual growth for the top decile in OECD countries over the period was 1.9%.
• Low income Australians also saw relatively strong growth from the 80s to the 2000s, growing at an average of 3% per year. Interestingly, the only countries in which low income earners saw stronger gains were Portugal, Ireland, Greece and Spain.
• Overall inequality in Australia, measured by the Gini coefficient, is slightly higher than the OECD average, though I wouldn’t put too much stock in the small difference between us and the average.
• We achieve less of a reduction in inequality inequality via taxes and transfers than we did a decade ago.
• “Labour market trends have been a key driver of inequality in Australia.”
• The share of income going to the top 1% has roughly doubled since 1980 (which we already knew from Andrew Leigh’s work), while the taxes paid by high income earners have fallen.

I plan to post more detailed analysis when I’ve had a chance to read the full report.

The problem starts with the title of his post: “Eurozone v Australia: Why We Beat Them”. The idea seems to be that Europe’s woes and our comparative fiscal and economic strength means we have “won”. This is a mercantilist fallacy banished by Smith and Ricardo centuries ago. Europe’s weakness harms us. We would be better off if Europe’s economy was growing strongly. Countries do not compete with each other in this way; trade is not a zero-sum game.

The rest of the post amounts to an assertion that Australian governments are in good fiscal shape (with low a debt-to-GDP ratio and moderate bond yields) because our government occupies a small share of the economy, due to means-targeting of welfare. This is the story that conservatives are trying to tell about the sovereign debt crisis: that European countries tax & spend too much, and that the bond markets have finally stopped the party.

Carr suggests that our relatively low social spending “has made it possible for Australian State and Federal governments to pursue policies of debt retirement”. It’s a strange argument. The ability to pay down debt is obviously a function of both spending and taxes; if government spending accounted for 40% of the economy, but taxes accounted for 41%, there would be a budget surplus and the stock of debt would decline. If spending was tightly means tested, accounting for only 25% of GDP, but taxes were light and accounted for 24%, the budget would be in deficit and the stock of debt would grow.

If Carr’s explanation of the crisis were correct, we’d expect to see higher bond yields in countries with higher tax-to-GDP ratios. We don’t. Sweden’s taxes account for around 47% of its GDP, yet last time I checked it could borrow funds at 1.62%. Ireland has around the same tax-to-GDP ratio as Australia, yet the yield on its bonds is over 8%. The two charts below (the first with Greece, the second without) tell the tale. If Carr’s story was true – that the size of the public sector is the main cause of the Euro crisis – then we’d expect to see the dots in these charts sloping upwards from the bottom left to the top-right. In other words, the bigger the government (as a proportion of the economy), the bigger the bond yield.

Tax-to-GDP ratio and bond yields in OECD countries

Tax-to-GDP ratio and bond yields in OECD countries (excluding Greece)

The Carr story just isn’t there in the data.

What if we just look at social expenditure? The story is the same: there are high-spending countries that are in trouble (Italy, Portugal) and high-spending countries that aren’t in trouble (Denmark, Finland). There are low spending countries that are struggling (Ireland) and some that aren’t (Australia).

Public social expenditure and bond yields in the OECD

Public social expenditure and bond yields in the OECD (excluding Greece)

If we set aside the bond yields and just look at the stock of government debt, it’s difficult to find evidence for the story Carr’s trying to tell. Japan taxes at about the same level as us, but has far, far more debt. Norway taxes a lot more, but its debt ratio is also low. Italy’s tax ratio is about the same as Norway’s, but its stock of government debt is huge.

The European sovereign debt crisis is about a currency area that encompasses too many diverse regions, with too little fiscal integration and weak oversight. It’s about a central bank that is reluctant (or unable, depending on your point of view) to play the role of lender of last resort. In the case of Greece, yes, it’s about a government that spent too much, taxed too little, and fiddled its books to hide its deficit. But look at Ireland: it’s a low-tax, low-spending country that was held up as a paragon of fiscal virtue by conservatives before 2007. George Osborne declared Ireland to be “a shining example of the art of the possible in long-term economic policymaking.”

The crisis is not about the welfare state. I can’t understand Carr’s motivation in suggesting otherwise.

NOTE: The bond yields data are from Trading Economics. The other data are from OECD Stat. The countries included are the 27 OECD nations for which Trading Economics has information about bond yields. I’ve used the most recent OECD data available.

• The US and Canada have taken different approaches to defining their official poverty threshold in recent years. We’ve solved this problem by not having one.
• Nicholas Gruen has written about the need for more humility and open-mindedness from economists, following on from this paper which argues that economists should see themselves less as scientists and more as engineers.
• The UK can now borrow more cheaply than Germany, challenging some of the narratives that have surrounded the Euro crisis.
• Should Australia move to shore up bank funding in a more explicit way?
• It’s the first edition of the ACTU Wages Report! By me! With graphs!
• Did behavioural economics backfire on the Obama administration?
• Dean Baker has a free e-book out called The End of Loser Liberalism, which is worth a read. He argues that progressives “have accepted a framing where conservatives want market outcomes whereas liberals want the government to intervene to bring about outcomes that they consider fair”.
• Here’s a two part interview with Dean Baker about his book.
• Interesting presentation by Peter Whiteford on inequality and social support in Australia.
• Mike Konczal on how inequality got so bad in the US, and what can be done to fix it.
• The “anxiety of the forever renter” in The Atlantic.
• Why doesn’t Britain make things any more?

He goes through the data and finds that the big four are making returns on equity in the vicinity of 18-20 per cent, suggesting that “the profits of major banks in Australia were the highest in the world during 2010″. Rogers summarises:

In other words, while bank executives continue to talk about “challenging” conditions, the data suggests the opposite: bank returns are rising, and are nearing levels experienced in the later years of the boom.

We would clearly rather have profitable banks than unprofitable banks, but is it right that highly protected institutions are able to deliver circa 20 per cent returns? The risk associated with those returns is greatly reduced by the implicit and explicit taxpayer guarantees attached to our banks, making the profitability of Australian banks the business of all of us.

As Chris Joye put it,

[T]axpayers have effectively said that they will insure away the risk of bank failure… what do these actions tell us? They clearly illustrate that bank shareholders get the benefit of a raft of… protections that are not supplied to other private companies. Given taxpayers have revealed that they are willing to insure away much of the downside risk associated with catastrophic bank failure, these institutions have, by definition, significantly lower equity risk.

If the probability of loss associated with investing with the majors has declined care of these profound changes to our prudential system… the expected returns should also fall. 

Joye goes on to ask the crucial questions:

given their protected-species status, should the banks be subject to stricter regulatory constraints on what businesses they can and cannot operate? Should they just stick to their knitting and focus on savings and loans? Do they need to be stockbrokers, corporate financiers, investment bankers, proprietary traders, and bankers to businesses and home owners in, say, China?

Wandering around Singapore recently, I saw a double-decker bus covered in advertising for ANZ, and pondered similar questions.

For example, this quote from Stephen Matchett in today’s Oz [paywalled], regarding the slowdown in productivity growth, riled me enough that I couldn’t let it through to the keeper.

So what went wrong?

The ACTU says nothing, that productivity was always a con. The economy did not speed up because we rowed smarter but because we were lashed into rowing faster. We wage slaves slump exhausted over the economy’s oars now the economic trireme is drifting.

Well, that’s news to me. I don’t recall seeing any statements from the ACTU that suggested that productivity was “always a con”. In fact, the ACTU issued a discussion paper less than two weeks ago on this very topic and nothing in it could be taken as a claim that “productivity was always a con”.

Here are a couple of quotes:

Increasing productivity is, in the long run, the main way that societies can improve their material standards of living. Productivity growth is the main driver of real economic growth, with workforce participation and population changes playing much smaller roles. True productivity growth is in the interests of workers.

…

Productivity growth is a necessary component of any social-democratic agenda for improving the lives of working people. Unions support productivity growth, but it is important that the concept and its relationship to public policy are properly understood.

…

Over the long-run, the trend rate of growth in Australian labour productivity is around 2 per cent. Australia experienced a productivity slump in the mid-1980s, growing well below trend, and a surge in the mid-1990s. The rate of growth in productivity has been falling since that time.

So far, so reasonable, I’d like to hope. But calm analysis like that doesn’t fit the ‘unions are the enemies of productivity growth’ argument that Matchett was evidently keen to advance. The solution? Just make something up. Claim that “the ACTU says… that productivity was always a con”. I gather that Matchett’s column is supposed to be vaguely humorous, so a certain degree of latitude should be granted, but I don’t think that should extend to completely misrepresenting an organisation’s position on such an important and prominent issue.

Grace Collier, union official turned employer-side industrial relations consultant, had a column in yesterday’s edition of The Australian. I found it quite offensive. Here’s a snippet:

HAVING a union presence in your business is like having a bear in your lounge room.

 You may think you have a good relationship with it, but it is a wild animal and one day it may be big, strong and of a mind to tear down your walls and eat your children.

Eat your children? Really? Can you imagine a newspaper printing that sort of comment by a union official about an employer representative in an op-ed? Perhaps I’m being too hyper-literal, but I can’t imagine a similar comment being dismissed as mere analogy if the roles were reversed.

She then turned to attacking Fair Work Australia:

It is true industrial relations outcomes are determined less by what the rules are than who the umpire is and right now the union’s umpire is on the field…

The union’s umpire? Really?

The President of Fair Work Australia, Justice Giudice, was appointed as President of FWA’s predecessor, the Australian Industrial Relations Commission, on 17 September 1997. You may recall that the Howard Government was in office at the time. Peter Reith was Minister for Workplace Relations, a man not noted for his union sympathies. FWA has two Vice Presidents, both of whom were appointed to the AIRC by the Howard Government, one in 2002 and one in 2006. Some of the other Deputy Presidents and Commissioners have union backgrounds, but I hardly think this is an institution that deserves sneering dismissal as “the union’s umpire”.

Continuing the theme of dodgy factual claims, Collier adds:

Since 1992, governments have left the productivity agenda to industry partners to achieve and the outcomes have been pathetic.

Pathetic? Really? In the 1990s, our rate of labour productivity growth outpaced the US and the rest of the OECD. It was more than double the average rate recorded in the 1980s. In the 2000s, a decade in which the various incarnations of the Coalition’s Workplace Relations Act were in effect until 1 July 2009, our rate of productivity growth fell below that of the US, but remained above the rest of the OECD.

Average annual growth in labour productivity (percentage points)

[Source: Treasury 2009 using data from The Conference Board]

I examine the facts about industrial relations and productivity growth in greater detail in this new ACTU Working Australia paper, though facts don’t seem to play much of a role in this debate.

It’s important to bear in mind that Australia is not the US. Inequality here is lower than in the US, social mobility is much higher; the unemployment rate is much lower. Whereas real median wages in the US have stagnated for decades, we’ve seen fairly solid real income growth across the income distribution. I think  that Australians who are concerned about rising inequality should be aware of the facts, so as to avoid making overblown and unsubstantiated claims. It’s easy to dismiss people’s arguments if they’re based on a misunderstanding of the facts.

Below, I set out some facts about income inequality (as distinct from wealth inequality, which is quite a bit higher than income inequality in Australia and elsewhere).

The share of income going to the top 1% in Australia has doubled in the past 30 years or so. [fn1]

According to the ATO’s tax statistics, if you earned $248 192 or more in 2008-09, you were part of the top 1%. The average income for an individual in the top 1% of taxpayers was $554 185. The median income for that year was $45 200, so the average income for someone in the top 1% was more than 12 times the median.

Top 1% income share in Australia

This is a pattern common to many developed countries – a ‘great compression’ in the three decades or so following World War 2, and then a ‘great divergence’ beginning in the late 1970s or early 1980s.

Even though the pattern is the same, the extent of the compression and divergence has been quite different across countries. The US is the extreme example. At the end of WW2, their top 1% had about the same proportion of total income as Australia’s top 1%, but our great compression was more pronounced and lasted longer than theirs. Our great divergence has also been less severe. Our top 1% has increased its share of income from around 5% to around 10% in the past 30 years, whereas the top 1% in America has increased its share from about 8% in 1981 to around 18% in 2007. Note that figures which include capital gains put the 1% share in the US closer to 25%.

Top 1% income share in Australia and the US

When you add in the other OECD countries, it looks like Australia’s top 1% income share is around the middle of the pack. It’s important to bear in mind here that these figures relate to pre-tax income; countries that have a similar pre-tax distribution but differing degrees of redistribution through the tax and transfer systems will end up with very different levels of inequality in net incomes.

Top 1% income share in OECD countries since WW2

It’s a bit hard to figure out which country is which in that tangle of coloured spaghetti, so the chart below shows the top 1% income share for selected OECD countries in 2005. I chose 2005 simply because that’s the most recent year for which the World Top Incomes Database has information for more than a handful of countries.  Again, this shows Australia as middle of the pack among developed nations for the share of gross income going to the top 1%. [UPDATE: A helpful reader pointed out that Norway's top 1% share spiked in 2005 due to tax changes in 2006, as can be seen in the chart above].

Top 1% income share in selected OECD countries in 2005

Of course, the top 1% income share is a very interesting piece of information, but it doesn’t tell us anything about the distribution of income among the rest of the 99% of the population. To get a more complete picture of income inequality, we need to use a measure like the 90:10 ratio or the Gini coefficient. A Gini of 0 implies perfect equality of incomes (everyone has the same income), whereas a Gini of 1 implies perfect inequality (one household has all the income). The closer a country is to a Gini of 1, the less equal its distribution. The data here are for net incomes, after taxes and transfers, and are based on household income, adjusted for household size. [fn2]

Measured using the Gini, our level of inequality (0.3) in the mid-2000s was slightly below the OECD average (0.31), but in a similar bracket to most European countries. Our level of inequality was below the level of most other English-speaking countries, and significantly below the United States (0.38). Although our income tax system has become less redistributive in the past decade or so, the tax and transfer systems as a whole still reduce inequality quite a bit in Australia.

Gini coefficient in OECD countries in the mid-2000s

Although inequality in Australia was middle-of-the-pack in the mid-2000s, the Gini in Australia has been drifting upwards. It rose from from around 0.29 in the mid-90s to around 0.33 in 2009-10. Between 2003-04 and 2009-10, the Gini in Australia increased by 0.022 points, a 7.2% increase in inequality.

Over this period, the share of household income going to the top 20% of households increased from 38.4%  to 40.2%, after reaching 41% in 2007-08. In 2003-04, a household at the 90th percentile of the income distribution had 3.87 times the income of a household at the tenth percentile. In 2009-10 this ratio was 4.21 times. This increase in inequality has happened during the mining boom period, and also during a period in which the income tax system was flattened out a fair bit. It’s likely that both factors have contributed to the rise in income inequality in the mid-to-late 2000s.

The OECD inequality data currently don’t go beyond the mid-2000s, so it’s difficult to say whether other countries have also become less equal over the same period.

Gini coefficient in Australia – mid 1990s to late 2000s

One of the most biggest problems associated with higher inequality is lower social mobility – the longer the ladder between top and bottom, the harder it is to make it to the top. Researchers measure this mobility as the relationship between an individual’s earnings and his or her parents’ earnings. If this is 1.0, then your income can be predicted with 100% accuracy based on what your parents earn. This implies no social mobility. If the figure is 0, then your earnings have no relationship to your parents’ earnings, implying high mobility. Australia has a moderate level of social mobility, according to research by Andrew Leigh, with an intergenerational elasticity of earnings in the range of 0.2 to 0.3. Dr Leigh explains:

In other words, a 10% increase in a father’s earnings translates into a 2-3% increase in his son’s earnings. In terms of international rankings, this suggests that Australia is more socially mobile than the US (IGE=0.4-0.6), less socially mobile than Scandinavia (IGE=about 0.2), and approximately as socially mobile as the UK. Given that’s where we fit in the inequality rankings, this feels about right to me.

I’ve written before about my belief that inequality matters. Even if we manage to eliminate absolute poverty within a country, inequality can still have pernicious effects on society and on individuals. One of the most harmful potential effects is that, over time, large inequalities of outcomes can undermine equality of opportunity, making it less likely that hard working, smart kids from poorer backgrounds will have a chance to achieve their potential. However, it’s important to keep the debate in perspective, at least as far as Australia is concerned. Income inequality here is rising, but it’s still relatively moderate. We should be vigilant to make sure that that our relatively egalitarian society stays that way.

NOTE: An earlier version of this post used a chart from the OECD to suggest that Australia’s level of intergenerational social mobility is relatively high. The OECD report used underlying data from a working paper by Andrew Leigh. The final version of his paper had a different finding about the level of mobility, but unfortunately the OECD report remains online with the original chart intact. I have updated my post to take account of this. Dr Leigh explains the whole situation here.

[fn1] The charts on the income shares of the top 1% are based on data from the World Top Incomes Database.

[fn2] Equivalised household disposable income is used for the OECD Gini data.

Albrechtsen:

The biggest problem when you hit the rich with higher taxes is behavioural. Here, the please-tax-me-more brigade might wish to take a look at the work of Arthur Laffer, a prominent economist during the Reagan administration. He and Ronald Reagan understood that lowering tax rates, rather than hiking them, led to increases in taxable income revenues…. When you tax people more, their incentive to work more and earn more income drops off. It’s “pure commonsense”, Laffer says.

Albrechtsen seems to believe that we are always to the right of the peak in the Laffer curve. On this view, tax revenues would presumably be maximised with tax rates of 1%. This implies that we don’t need to choose between higher tax rates with higher revenues on the one hand, or lower rates with lower revenues on the other. We can have low tax rates and maintain or increase our current revenues! All that is standing in our way, seemingly, is a bunch of short-sighted politicians, prodded along by class warriors who seek higher rates for no reason other than spite or envy.

The problem is that there is little empirical support for claims that cuts in tax rates from the rates that currently prevail in countries like the US and Australia will result in increased revenue. Even conservative Republican economists dispute the notion that tax cuts pay for themselves.

Bruce Bartlett, an official in both the Reagan and George H.W. Bush administrations, has said:

The original supply-siders suggested that some tax cuts, under very special circumstances, might actually raise federal revenues…

But today it is common to hear tax cutters claim, implausibly, that all tax cuts raise revenue. 

Here’s what N. Gregory Mankiw, Chairman of the Council of Economic Advisers in the George W. Bush administration, had to say about the Laffer curve and the Reagan tax cuts in the 1998 edition of his textbook:

An example of fad economics occurred in 1980, when a small group of economists advised presidential candidate Ronald Reagan that an across-the-board cut in income tax rates would raise tax revenue. They argued that if people could keep a higher fraction of their income, people would work harder to earn more income. Even though tax rates would be lower, income would raise by so much, they claimed, that tax revenue would rise.

Almost all professional economists, including most of those who supported Reagan’s proposal to cut taxes, viewed this outcome as too optimistic. Lower tax rates might encourage people to work harder, and this extra effort would offset the direct effects of lower tax rates to some extent. But there was no credible evidence that work effort would rise by enough to caues tax revenues to rise in the face of lower tax rates. George Bush, also a presidential candidate in 1980, agreed with most of the professional economists: He called this idea “voodoo economics.”

Nonetheless, the argument was appealing to Reagan, and it shaped the 1980 presidential campaign and the economic policies of the 1980s…. Congress passed the cut in tax rates… but the tax cut did not cause tax revenue to rise… tax revenue fell.

Mankiw’s position seems to be that, over the long run, tax cuts do have a positive effect on incentives. This means that some of the revenue lost via tax cuts is recouped via increased economic activitiy. This is a fairly uncontroversial proposition. However, his work on the size of this behavioural effect suggests it’s much smaller than Albrechtsen claims.

Here’s Mankiw in 2007:

In a paper on dynamic scoring, written while I was working at the White House, Matthew Weinzierl and I estimated that a broad-based income tax cut (applying to both capital and labor income) would recoup only about a quarter of the lost revenue through supply-side growth effects

This estimate accords with studies of the effect of the Reagan tax cuts of the early 1980s. Lawrence Lindsey, who was Senior Staff Economist for Tax Policy in the Reagan Administration and later served in the G.W. Bush administration, found that:

…at least one-sixth, and probably one-quarter, of the revenue loss ascribable to the rate reductions was recouped by changes in taxpayer behaviour.

In other words, for each dollar of tax revenue that is given up through tax cuts, the Government recoups around 15-25 cents through an increase in taxable income. Bear in mind that these estimates are those of conservative economists who worked in the White House under Republican Presidents. Their estimates of the effect of tax cuts on revenues should therefore be assumed to be on the high side.

Such tax cuts, on the Republicans’ estimates, still leave three-quarters to five-sixths of the lost revenue to be accounted for in some way. This can either be done by raising other taxes, cutting spending, or running persistent budget deficits.

If conservatives want to argue for a diminished role for Government, they should make the argument on its own terms, rather than hiding behind spurious suggestions that we can have our cake and eat it too. As Laffer himself has said, “”The Laffer Curve should not be the reason you raise or lower taxes.”

UPDATE: Here’s a useful summary of various views as to where the peak in the Laffer curve lies.

Following years of poor decisions by governments, we have a planning system that puts developers – not people – first.  

Many of us accept that Melbourne can’t keep sprawling outwards. But bringing more people into the city will only work if we invest in infrastructure, keep our open spaces and preserve Melbourne’s character and liveability.

Housing is becoming less affordable in inner-city Melbourne, but the guiding principle seems to be to turn every old warehouse or vacant site into expensive, high-rise apartments.

Adam Bandt wants more affordable housing, yet laments the trend to turn warehouses and vacant sites into new dwellings. This seems to be a widely-held view. People like affordable housing (at least in the abstract), but they don’t like change. I don’t understand the model of the housing market that people carry around in their heads if they think this way.

How can you reconcile a desire to see:

• consistent population growth;
• access to affordable housing;
• no expansion of the urban growth boundary; and
• strict restrictions on new development in existing areas?

The way I understand the housing market, the price is determined by the supply and demand for housing. If supply is artificially restricted, the price will rise. That may be a policy goal you wish to pursue, but it is not consistent with the policy goal of increasing access to affordable housing. There are trade-offs here that cannot just be waved away.

The negative effects of housing supply restrictions on productivity, creativity, and affordability are covered in a well-argued new Kindle single by Ryan Avent (of The Economist)  called The Gated City. Avent understands what motivates people to want to resist development:

Their actions aren’t necessarily nefarious. Most just want to protect neighborhoods, views, and buildings they love from changes they fear. But the cumulative effect of this battle against change is dramatic.

This is the key point. The small decisions to restrict housing supply, one apartment block or subdivision at a time, add up to less affordable cities.

The problem, as Avent says, is that:

No one in the city represents the residents or businesses that might want to live or operate in the developments yet to be built. But their interests should matter…

[T]he lion’s share of the cost of exclusion falls on the excluded. That’s why the practice of shutting others out is so attractive and so common. No policy I can suggest will be as effective as the understanding that the welfare of outsiders matters. 

Choose to support stringent restrictions on housing development, or support access to affordable housing. You can’t choose both.

You cannot take the politics out of tax. The question of how much is to be raised, the manner in which it will be raised, the balance between various revenue sources, and Governments’ allocation of revenue between expenditure items is intensely political. There is not some ‘right’ answer that an independent body of enlightened technocrats could stumble on, if only vested interests and politicians got out of the way.

When faced with a choice between equity, efficiency, and simplicity, governments can’t say “all of the above”. They have to choose between these ends. Their choice will inevitably be a compromise between competing interests and views, satisfying purists of no political persuasion and irritating tax accountants and lawyers who see the flaws of the legislation up close. This compromise between competing ends is a feature, not a bug.

Let’s take the issue of business tax. Before any Commission got to ‘evaluating reform blueprints’, they’d want to establish some facts about where we stand, both relative to our past and relative to other countries. What is the appropriate metric? Should we just compare statutory company income tax rates, or should we look at the effective rates once various loopholes, exemptions and deductions are taken into account? Instead of comparing rates, should we look at business tax a a proportion of GDP? Or should it be as a proportion of revenue? Should we include various other taxes if their legal incidence falls upon business? To what extent should we take into account the fact that the economic incidence of a tax is not necessarily the same as the legal incidence? If we are to take this into account, which of the array of studies should we lean upon to determine the distribution of this burden between capital and labour?

Once we’ve settled all of those questions, we still haven’t got far. We still need to decide which other countries we should compare ourselves to. Should we just look at the OECD? If so, should we weight OECD countries by population? Or perhaps we should only look at OECD countries that are similar to us in some way, either in terms of their social safety net, or their broad institutional structure, or the size of their economy? Maybe the OECD countries aren’t the right comparators at all; perhaps we should be looking at countries in our region, like Singapore or Hong Kong. How do we take account of the various non-tax regulations that affect business decisions in each country?

Each of these is an important question. I don’t think there is a ‘right’ answer to any of them. Perhaps you might suggest that a ‘reform commission’ would merely present ALL pertinent facts, essentially answering ‘yes’ to all the questions above. That would still leave the question of what is to be done, a question that ultimately should not and must not be delegated from our elected representatives. Maybe the Commission would merely model the economic and fiscal effects of various groups’ reform proposals. This could be useful, but I’m not sure it would ultimately be particularly helpful to governments (and they can, of course, already obtain such advice from Treasury and Finance). Governments would still need to choose between competing ends and between competing views.

I’m all for expanding the range of evidence that is available from trusted sources. I’m all for the idea of Government support for independent research, like the announcement that Wayne Swan made yesterday. I am just wary of the ideas that purport to take the politics out of politics.

The paper addresses some common misconceptions about our tax system and Australians’ attitudes to taxation. Here’s a key chart, showing that Australian governments spend and tax less, as a proportion of national income, than the governments of almost all other developed countries [fn1]:

Reminder: this blog represents my own personal views, etc. etc. 

[fn1] This is an updated version of a similar chart that was included in the Henry Review report.

-Lindsay Tanner, Sideshow

The ‘cost of living’ debate irritates me.

On the one hand, we have commentators like Bernard Keane who describe complaints about the rising cost of living as “whingenomics“. This account goes: our standard of living is among the best in the world, inflation is moderate, wages are rising, so what are people on about? While there is a substantial dollop of truth in this account, it ignores the fact that decent economic performance, as measured by aggregates or averages, can disguise significant diversion in the lived experience of citizens: a rising tide might not necessarily lift all boats.

The other side of the debate is dominated by the tabloid press  and political oppositions (at the state and federal level), who seem to take great glee in convincing the public that they’re doing it tough, and that it’s the responsibility of government to alleviate any financial pressure they might feel.

A new paper by Tim Soutphommasane of Per Capita, Just Get Over It: The Cost of Living in Australia, tends towards the first of these views. Soutphommasane’s argument is more nuanced and sympathetic than Keane’s, conceding as he does that “many Australians, particularly those on fixed and low incomes, face economic pressures from rising food and electricity prices, when they do occur”. Yet the view expressed in this paper, as its title would suggest, is that “cost of living pressures” are a largely imagined problem, and that in any case it is not governments’ duty to intervene to address them beyond ensuring some minimal level of frugal comfort.

I have no doubt that some people who complain about the cost of living are reporting a largely imagined problem. People with upper-middle and high incomes seem increasingly willing to conceive of themselves as hard-done-by battlers, deserving of assistance by governments. Downward envy seems as if it’s on the rise, a lamentable development. Yet I’m less convinced than Soutphommasane that cost of living complaints are mere superficial worries that people should “just get over”.

Between 2007-08 and 2009-10, the global financial crisis period, the incomes of most Australian households declined after inflation. The bottom quintile gained a little, mostly as a result of the significant increase in pensions that the federal government implemented in that period, but the other 80% of households went backwards. Since that time, the economy has grown strongly, wage growth has returned to around its long-term average pace, and household incomes have almost certainly regained lost ground as a result. Nevertheless, the last few years have been ones of global anxiety and uncertainty, with our domestic economy undergoing spasms of structural change. Since our recovery from the GFC began in mid-2009, the cost of living for employee households has risen by 5.7%, while the headline CPI has only increased by 3.8%. Given such a backdrop, a bit of worry about household finances doesn’t seem entirely misplaced.

I don’t want to overplay this – our economy, on almost all measures, has outperformed the rest of the developed world. Our wages have risen, jobs growth has been strong, underlying inflation remains consistent with the central bank’s target. All I’m suggesting is that there are some reasons to suspect that there is a kernel of truth to some people’s complaints about financial anxiety – it is not a purely imagined phenomenon.

Setting that question aside, if we take the core argument of Just Get Over It as given and concede, for the sake of argument, that cost of living pressures are largely imagined, why has our polity seemingly self-combusted in 2011 with an overwhelming amount of concern about this imaginary problem? In my view, Soutphomassane offers too little analysis of the forces that have generated this mass hysteria. Soutphommasane implies a sort of false consciousness has taken hold across middle Australia, leading people to conceive of themselves as doing worse than they really are. Why might this be? There is some reference to opposition political parties, from Latham’s “ease the squeeze” onwards, capitalising on a generalised sense of unease about economic matters, but this isn’t unpacked sufficiently to give a satisfying account of the rise of the sense of “crisis” that has come to surround the cost of living issue.

Soutphommasane suggests that perhaps our rising collective affluence leads to rising anxiety about the cost of living: as we acquire larger houses and use more power, we become more sensitive to changes in the cost of goods like electricity. This is true, to an extent (people living in small council flats are also pretty sensitive to power prices), but this is an unsatisfying explanation of why the cost of living has proven to be a particularly potent political issue in 2011 rather than in some other year. The paper’s charts of power consumption and floor sizes show a fairly consistent upward trend for decades; there is little apparent reason why these factors should explain the sudden explosion of the cost of living as a political issue this year. The partisan contest over the cost of living and media coverage of the issue both seem to be to be prime candidates for explaining the rise of the issue’s salience, yet neither receive much attention in this paper. If Tony Abbott is determined to convince relatively affluent people that they’re doing it tough, and the media is more than happy to give him the space to do so, then it’s no surprise that people start to believe it.

While I’m in broad agreement with Soutphommasane’s view of governments’ role in addressing upper-middle and high income earners’ concerns about the cost of living, I worry a little about the narrowness of his seemingly pre-Rawlsian conception of the role of the state’s broader responsibilities. He thinks that the state’s responsibilities extend only to providing for “equal opportunity, public goods, and assistance in times of hardship”. In my view, this tends towards what Mike Konzcal memorably described as “pity-charity liberalism”, a kind of hands-off approach tempered only by support for the most disadvantaged.

Notwithstanding my various quibbles, this is a sober and worthwhile look at the ‘cost of living’ issue that is cogent in its ultimate conclusion: that there is no generalised cost of living ‘crisis’, although particular households are doing it tough.

A group of semi-retired Coast men has been left hurt and angry after their plans for a social club at Palmwoods were thwarted by claims they could present a danger to children living nearby.

The men started the Sunshine Valley Men’s Shed group as part of the national initiative to improve the health of older men by giving them a chance to socialise and work together.

But the dream has been crushed after a nearby resident made an official complaint to council, saying a large gathering of elderly men could be a danger to local children.

This comes after recent news that the Byron Bay Council is trying to effectively prohibit large festivals (like Splendour in the Grass or Blues and Roots) from taking place within its boundaries by imposing strict new restrictions.

What do these stories have in common? They show the way that local councils can be used to prevent change and to promote the self-interest of small cliques of local residents.

We accord too much power to lone NIMBYs, in my view. Why should one man, with a preposterous and frankly offensive objection in the case of the men’s shed, be able to stand in the way of a initiative that could benefit a whole community? Now, this particular shed may well be approved; an objection isn’t necessarily fatal to the group’s plans. Nevertheless, there are many instances in which local councils have proven particularly susceptible to capture by minority interests.

A few years ago, the once-great Grosvenor Hotel in Perth was forced to close its back room and cease hosting live bands because of noise complaints from one resident. One. This resident moved to the Perth CBD, near a pub that had been operating for decades, and proceeded to have it shut down because he didn’t like the noise. Why was his objection given so much weight? Why wasn’t there some recognition given to the fact that the pub was there first, and that he knew (or should have known) that it hosted live bands before he bought a flat nearby?

The case of the Grosvenor was one in which a NIMBY was able to shut down an existing institution. Far more common is the scenario in which people are able to prevent new developments (of whatever kind) from being approved in the first place. Be it a new apartment block; a small bar; a sports ground; a public housing facility; a drug and alcohol clinic; or a music festival, a couple of noisy, well-organised residents are often enough to swing the meagre apparatus of their local government against change and in favour of the status quo.

Sometimes the objections might be genuine. Sometimes they might be well-founded. Often they’re not. Residents who object to a new apartment block might just be trying to restrict new development to maintain growth in house prices, or to prop up rents. They are perfectly entitled to defend their investments, but their interests should be weighed against broader interests. There should be no automatic presumption in favour of noisy objectors, as it sometimes seems there is.

This isn’t a left-right issue, either. It seems to me that people with a wide range of political views should recognise and resist the seemingly structural problem we have at the local government level. [fn1] Progressives who are worried about housing affordability should take a generally sceptical view of opposition to new apartment developments, as should environmentalists who are worried about urban sprawl. Libertarians should recognise that much of the most pernicious, liberty-impeding regulation occurs at the local government level.

We should all be aware that some of the most important political battles are the small ones, fought at the local level, that rarely make it into the national papers. It’s our collective inattention that allows local government to be captured and swayed in this way.

[fn1] Now, of course, sometimes the status quo is worth preserving. I like the fact that Melbourne (unlike Perth) has kept much of its old architectural character; the juxtaposition of RMIT’s bold, seemingly Mario 64-inspired campus and the State Library’s grand old pillars on opposite sides of La Trobe St sums up a lot of what I like about Melbourne. I’m not arguing that people shouldn’t have the right to lobby against new developments, be it on aesthetic grounds or otherwise. I’m just arguing against the automatic presumption in favour of the status quo.

As always, this post represents my own personal views alone. 

I told myself I’d lay off, but I can’t resist responding to Michael Stutchbury’s piece in today’s edition of The Australian.

Yesterday afternoon I listened to the Q&A session that followed the RBA Governor’s interesting speech about consumer caution. Stutchbury asked the first question, part of which concerned the slowdown in productivity growth and the implications for public policy. Fair enough, it’s an important question. Glenn Stevens gave a considered, though oblique answer in that central bankerly style of his.

This morning, though, Stutchbury’s column (is it opinion, or reportage? I find it hard to tell) stretched the Governor’s words too far.

Here’s the relevant section of his piece:

“It is now just about impossible to avoid the conclusion that productivity growth performance has been quite poor since at least the mid-2000s,” Stevens says.

The problem is that Australia took its eye off the productivity ball when the China boom started showering us with money.

It’s not an easy thing to fix, the RBA governor agrees, but he nominates “sensible labour market regulation” as one place to start.

The problem is that the Governor did not, in fact, nominate ‘sensible labour market regulation’ as “one place to start.”

What he actually said was:

In terms of productivity, I think it’s probably not wise for me to list a whole bunch of detailed things, but we know that the overall thrust of the things which produced productivity in the past were sensible labour market regulation, competitive product market regulation…

See that? He’s talking about past changes to regulation. To imply, as Stutchbury does, that the Governor nominated further changes to labour market regulation as a place to start in an effort to lift productivity growth now is to misrepresent Stevens’  answer to the question.

Besides which, what “sensible changes” is the Governor referring to? As Stutchbury himself reports, Stevens said in yesterday’s speech that “productivity growth performance has been quite poor since at least the mid-2000s”. Work Choices took effect from March 2006; it would be difficult indeed to conclude that Stevens was referring to this legislation when he mentioned productivity-enhancing labour market regulation. Instead, in my view he was probably referring to the shift towards bargaining at the enterprise level, a shift that occurred under the Keating Government and a policy stance that is at the heart of the Fair Work Act.

If I had read Stutchbury’s piece without having listened to the Q&A session that it quoted, I would have been left with what I believe to be a misleading impression about the Governor’s statement. If ideological warriors like Stutchbury want to campaign for changes to the industrial relations system then they’re obviously free to do so, but they shouldn’t distort the facts in the process.

This chart shows the proportion of the working-age population that is in employment. [fn1] In many ways it gives you a clearer picture of what’s going on in the labour market than the participation rate, as you are counted as ‘participating’ if you’re unemployed but actively seeking work. Think of this as the employment rate, as opposed to the unemployment rate.

Over 72% of working age Australians have jobs, while less than 65% of Americans or Europeans are in work. We drew level with the US in 2005 and overtook them in 2007. The Great Recession has taken a horrible toll on employment in the US, while it was barely a blip here. The US employment-to-population ratio is converging with Europe’s after being 10 percentage points higher than the European rate at the start of the decade.

If you break it down by age, the employment-to-population ratio in Australia is either greater than or equal to the rate in Europe or the US for all age groups. The gap between Australia and the others is particularly large among the younger age groups.

Female employment, and employment of older women in particular, has gone up strongly over the past decade in Australia…

…while female employment has fallen for most age groups in the US…

…and the EU 15.

These are a few charts to remember the next time you read about our ineffective stimulus packages, or that nasty, job-destroying Fair Work Act.

[fn1] I compiled these charts using OECD data – labour force statistics by sex and age, available from OECD Stat.

…look at inequality, as far as economic efficiency is concerned, as cholesterol: There is “good” and “bad” inequality, just as there is good and bad cholesterol. “Good” inequality is needed to create incentives for people to study, work hard, or start risky entrepreneurial projects. None of that can be done without providing some inequality in returns…

But “bad” inequality starts at a point – one not easy to define – where, rather than providing the motivation to excel, inequality provides the means to preserve acquired positions. This happens when inequality in wealth or income is used to forestall an economically positive change for the society… or to allow only the rich to get education, or to ensure that the rich keep the best jobs.

I’d broaden the definition of “bad” inequality, but this is a good start.

It all started when Matt Yglesias contributed to a debate at The Atlantic’s website by claiming that:

[t]he best step to create jobs and boost the [US] economy would be for the Federal Reserve’s Open Market Committee to announce a plan to target inflation at 3 or 4 percent.

This raised the hackles of Doug Henwood, who accused Yglesias and his fellow “left neo-liberals” of preferring monetary to fiscal remedies because:

…they operate through the financial markets and don’t mess with labor or product markets or the class structure. A jobs program and other New Deal-ish stuff would mess with labor and product markets and the class structure, and so it’s mostly verboten to talk that way.

Henry Farrell piled on, suggesting that “neo-liberals” like Yglesias

tend to favor a combination of market mechanisms and technocratic solutions to solve social problems. But these kinds of solutions tend to discount politics – and in particular political collective action, which requires strong collective actors such as trade unions. This means that vaguely-leftish versions of neo-liberalism often have weak theories of politics, and in particular of the politics of collective action.

At Mother Jones, Kevin Drum weighed in, tentatively coming down on the side of Farrell and Henwood, but with some sympathy for Yglesias. He explains his own drift from a more technocratic point of view to one that places greater emphasis on organised political power as the means to achieve progressive ends:

Back in the 90s, if you’d asked me what my political persuasion was, I probably would have said I was sort of a neoliberal (in the American, Charlie Peters-ish sense of the word). My political leanings are liberal, but my temperament is technocratic and market oriented, and that made me a pretty good fit for the neoliberal team.

I got steadily off that bus over the years… I’ve moved even further away from the neoliberal persuasion because my nose has been rubbed a little too firmly in the fact that it simply doesn’t work politically. The world is a messy place governed by messy interest groups and messy countervailing powers, and if you absent yourself from that world you’ll get steamrolled.

At this point, Yglesias professed that he had “no idea what it is that we’re disagreeing about”. He claims to “really, strongly, profoundly agree” that rebuilding an organised left and “the infrastructure of economic populism” is a good idea, but in the absence of a concrete proposal to achieve that aim he declares that “[d]ebating the desirability of devising some hypothetical future good idea seems kind of pointless to me”.

Henry Farrell wasn’t happy that Yglesias “waxed sarcastic” about the whole thing, responding with a lengthy critique of the lack of a “theory of politics” among so-called left neo-liberals like Yglesias. Farrell’s critique seems to amount to the suggestion that, by pursuing desirable economic policies without consideration for their second-order  effects on the dynamics of political power, left neo-liberals do little good and do some harm.

Brad DeLong doesn’t think that Farrell’s vision, of rebuilding organised coalitions of left-leaning groups to offset the strength of the organised right ,”is workable or advisable”.

Finally, Lane Kenworthy thinks that organised political power is important to achieving progressive outcomes from the policy process, saying that:

If you want progressive policies, the comparative historical evidence suggests it’s very helpful to have a strong labor movement. Indeed, after democracy, it might well be the single most valuable thing to have.

However, he also suggests a “second-best” alternative in countries where unions are “weak, and getting weaker” that involves broader coalitions of left-leaning interests.

The debate still seems to be raging, and it is a fascinating one.