In fact, it feels doubly strange when we think about the idea of getting some tax money from overseas and using that to pay for services - why would we want to sacrifice that?

But there is a pretty simple but illusive answer - Australia, although it is very important and beautiful, is not the only country in the world. We have an international tax system with international capital markets, and have to be aware of how this all functions.

Note: Apologises for the cringe ChatGPT cartoons - normally they are bad, but these are exceptionally dumb. But I’m dumb and they made me laugh so they are in.

The simple answer - people pay tax elsewhere

Lets not think about some abstract foregin resident and instead think about ourselves. Let’s say that we have some Microsoft shares that pay us a dividend, and we realise a capital gain on a few of them.

Microsoft is resident in the US. I am tax resident in Australia. Where should the tax be paid?

The US could tax me, and then Australia could tax me. That would be lame. Realising this the League of Nations created model tax treaties that recommended taxes were paid at “origin” or where the source of value comes from.

For active activities (i.e. using a factory to make some stuff) those taxing rights are where the activity takes place (source), but for many portfolio investments the origin is the residence of the investor.

Now there are always debates between countries about how this works, and things end up messy - this is not a clean conceptual distinction, so in the end it is about social convention and international agreement about where rights are allocated. But the goal of the double tax agreement is to avoid double taxation.

So take our US example. I would pay a 15% withholding tax in the US on the dividend income. I would be assessed on the full income in Australia, but provided a foreign income tax offset for the withholding tax paid in the US. In the end, I would pay the Australian tax rate on my income. For the capital gain, it would be fully taxed in Australia.

Now lets flip the script. Passive investment in Australia generates types of income that are taxable at the residence of the investor - this is not really Australian income to tax. Saying we should tax this at full rates is like the ATO wandering into New Zealand and charging a consumption tax.

The example with renewable investment is fairly mixed up - as there is a big debate about “what is land” and “how is it a source of value” when thinking about tax treatment.

In this case, a gain that reflects a land rich asset is still seen as having a “source” that is in the country where the land is - not just where the funding has come from.

By expanding the definition of land Australia is claiming more things are “sourced” here rather than overseas, and as far as I can tell this carve-out is a strange transitional rule about this change in definition.

I’m not defending it or attacking it. But once we think about international taxes a lot of the critiques we are seeing in public are pretty disingenuous - and read more like politics trying to trick people than outlining genuine concerns they may have with the policy.

I can hear one concern look at Microsoft, they shift income to Ireland and Singapore and don’t pay their fair share.

Man stop this, I can’t believe how popular this view is with people from all parts of this political spectrum. If the US allows companies to do this, they are essentially subsidising the company. They are subsidising Microsoft products provided to Australia. Why does this mean we can randomly tax the income of Microsoft?

Imagine I sell you a daily afternoon coffee and you find a cheap store to buy breakfast. Does this mean the “fair” thing for me to do is to make you pay a penalty when you come and see me? It is incoherent waffle that too many smart and credible people take seriously.

If you want to argue this, you need an agreement that the US and US companies are shifting part of the Australian tax base offshore - that is the motivation behind transfer pricing. It IS NOT directly about a residence country just charging a low tax rate.

A broader concern - capital mobility

For some they view this policy carve out as an admission that capital is mobile - and hence that the CGT reforms that will likely increase average capital tax rates were based on an inconsistent idea of how mobile capital is.

This is a much more reasonable argument than the one above.

But with this we do need to be a bit careful. Capital mobility fundamentally depends on how elastic the given capital flow is.

For example, if we are looking at foreign debt financing, people can provide such financing anywhere in the world and will hunt for the best yield (conditional on having good information about repayment and laws in the jurisdiction). So this type of porfolio investment will be hyper mobile.

This means foreign capital doesn’t pay the tax (another reason why such tax is residence based). If we imposed a tax on the interest earned from this foreign debt, the capital investor would only lend if they received a higher pre-tax rate of return - leaving the post-tax rate of return unchanged.

To achieve this wages must fall, domestic capital income must decline, or (perhaps) prices must rise. So it ends up being a tax on domestic factors of production.

So far, so sensible about why we would exclude tax on foreign portfolio investment - as we’d just be adding an additional tax on labour and domestic capital. But what about broader CGT.

As we mentioned earlier, not everything is international debt financing. So we need to be quite aware that the capital mobility argument may be much weaker if we are talking about the taxation of other types of capital income.

This is a point that is always worth further thought - but the perfect capital mobility idea is as ridiculous as the belief that higher taxes will not distort investment. The truth is between, and the best we can do is be incremental and use carful empirical work to understand trade-offs.

But if we believe a GST would be a good policy that wouldn’t distort investment, then a CGT with a normal rate of return allowance (and this applied to all capital income) is functionally equivalent to a GST. The key margin where they differ is avoidance - such capital mobility may allow you to avoid an income tax, but not a GST (as long as you stay living here). So maybe this is another point in favour of GST ;)

Conclusion

We tax foreign income differently to avoid double taxation. It isn’t really our income to tax.

Capital mobility can also be important, but isn’t the primary justification. If we do care about that, then maybe we need to swap some income tax for GST.

The topics discussed are as follows:

1. 1 min: What is income really - and what does capital and labour income mean?

2. 8 min: Why not just tax expenditure?

3. 16 min: Is Haig-Simons/Comprehensive Income a good benchmark? Does it tell us anything about the potential tax changes?

4. 28 mins: Do economists want to murder each other?

5. 32 mins: Deductions and negative gearing.

6. 37 mins: Tax distortions, investment selection, and risk.

7. 44 mins: Is a dual income tax system the solution?

8. 46 mins: Income shifting hot takes!

9. 53 mins: Individual or household taxation? And the importance of thinking about lifecycles.

10. 56 mins: What does GST have to do with this?

11. 60 mins: Taking the capital gain on human capital? Thinking about the taxation of unrealised gains.

If the goal is to tax real income the same way, no matter how it is earned, then indexation achieves this by removing the taxation of inflation. So that sounds reasonable at face value.

Now when I’ve chatted about indexation I was including a few other things to stay consistent with this principle, we’ll get to those later. Importantly a more recent concern has shown up - higher taxation of entrepreneurs.

This is an important topic that a lot of people appear uncertain about. So I’m keen to talk about it.

My goal is not to persuade you one way or another, but just to talk about the concepts - there are major ideas in this that need to be considered seriously whenever looking at the taxation of capital income. My views are here, but they are here to discuss rather than being fundamental truths of nature - so comment if you have questions or thoughts.

tl;dr Ok ok, let me copy this from the conclusion - as this post is a journey for those willing to take it, but we don’t all have that time.

My read is that replacing the CGT discount with indexation is defensible, including for founder gains. For founders with near-zero cost bases, the discount is not compensating for inflation, it is exempting part of a real gain.

But indexation alone is only a response to inflation - not other rationales for why there was differential tax treatment. Without income averaging, moderate founder gains can be taxed more harshly than equivalent income earned steadily over time. Without symmetric loss treatment, the system taxes successful risky projects more fully than it supports failed ones. And without careful interaction with imputation, expensing, and R&D policy, the system may still create avoidable distortions that prior policy makers were trying to address indirectly with the discount.

How does this work?

Imagine a situation where an entrepreneur appears with no equity, but through their innovation and time they build a company worth $1m after 10 years. Under indexation they would be taxed on that whole $1m when currently they would be taxed on $500,000.

Here the discount is not about inflation - there was no stock of savings that was losing value due to rising prices which needed to be compensated. Instead the discount is just saying that only half of the income will be taxed.

If this same person instead earned $100,000 per year they would end up taxed on $1m. So removing the discount is now making sure that income is being counted for tax the same way irrespective of how it is earned.

But this example definitely makes a lot of people uncomfortable. The main discomfort is increasing tax on those taking risk - we know from history that the evolution of limited liability companies were essential in the explosion of investment that helped to generate the high living standards we have today. As a result, the idea of disincentivising the risk feels, well, risky.

Now indexation doesn’t mean higher taxes on capital gains. If you had a low return the current system taxes you at higher rates. However, if part of a high expected return reflects compensation from risk, the use of a discount - rather than indexation - was a choice to tax risk-taking at lower rates in 1999.

Indexation taxes all this other income like wages. This other income reflects founders implicit wages/return to effort, economic rents earned, and compensation for risk. In the same way some have forcefully argued that we should tax “rents” more, we are now hearing people forcefully ask that we should tax “risk-taking” less. Both arguments deserve to be discussed.

The reaction people have - one way or another - is a view about how you feel about this question. As we’ll get to, how risk is being taxed gets complex, but you can understand why this is something that matters to people.

Note: What this is part of potential reforms a particular grey area as many of the circumstances are under current small business exemptions which may not be reformed in the Budget - as always the devil is in the detail!

Note 2: If you have read me in the past you’ll know my view on taxing rents - don’t differentiate in the income tax system, but then have a separate tax instrument that reflects that. By default I have the same view on risk - tax all the income the same way, then make a clear and considered case for a risk allowance/subsidy. But we can only get to that design if we are clear on how this all works.

Note 3: I do have to call out those saying that the “efforts” of founders should be taxed less than the efforts of others. Income tax asks for a contribution from everyone’s effort - the tax system is not about rewarding those we view as morally virtuous, it is about asking those who have the means to contribute to public goods and support of the most vulnerable. Trust me, if it was about moral virtue I don’t think the public would be demanding lower taxes on founders vs nurses and teachers.

Small business, innovation, unicorns, productivity

Right, ok. I do know those words and I understand why they excite you. High living standards depend on price discovery, competition, and entrepreneurship - finding new and better ways to do things, and destroying antiquated processes.

But let’s be a bit more systematic with that.

An entrepreneur is combining their insights, their willingness to take on personal risk, and their own labour time with the time and knowledge of their workers and the capital that has been built up within the firm. This capital may reflect physical plants and machinery that were purchased with external financing or retained earnings, or intangible capital and goodwill that builds up from the efforts of the entrepreneur and their employees.

Everyone involved buries themselves in the firm, and has a claim on a return based on contracts. The contract may limit risk by providing a given sum of money (i.e. a standard salary job) or it may be very risky by reflecting only the income of the firm.

Many of the founders that we are thinking about will take no or limited wages and rely only on a risky capital gain for their remuneration. They may do so for tax reasons - but often they do so because cash flow is limited, and high value investment in capital items relies on retained earnings in the early stages of the business.

Great, we are all on the same page about what is going on. So what happens here when we tax the income of entrepreneurs the same way as labour or (inflation adjusted) capital earnings. Are we concerned that we are now penalising risk?

This is an argument we need to be a bit careful of - as the income tax system essentially pulls the government in as a silent partner that bears part of the risk of the entrepreneurs investment. If the return is high, part of the benefit goes to the government in tax revenue. If there is a loss, the government provides a credit to the individual for future use.

If we view a risky investment like a bet and walk through how an income tax functions, the existence of income tax means that the individual can “scale up the bet” to essentially face the profile of risks. In this circumstance there is a tax burden that does change behaviour - but it is in the way the “risk-free return” is taxed, not a disincentive to take on risk itself.

The above author argues that the risk-free rate is really close to zero, so this doesn’t matter. Empirically, it appears they are half right - it does appear that capital gains tax rates are relatively unimportant for entrepreneurial activity, as explained in Hourani and Perret (2025). However, the OECD piece also points out that liquidity policies (not CGT, but investment expensing) do matter - a CGT discount is a blunt instrument for trying to achieve something other policies do better.

But say you are still worried about the way that a capital gains tax would function to reduce innovation. Specifically, you believe that someone coming in and disrupting the market is a unique factor of production that helps to boost productivity. If that is the case, it is consistent and correct to say that we shouldn’t be taxing capital income at all - and instead we should replace it with a recuring wealth tax.

I just missed the last part in the recent AFR articles on the topic, perhaps it will be included in a follow-up?

There is a little bit of jest here, but there is an important point behind this. If we could design a tax system so that people do the same activities they would in the absence of tax that would be great - that is what economists call efficient. Even better if we could encourage individuals to shift to investments where the social benefit is larger due to spillovers.

Having “successful bets” taxed at 30-40% doesn’t mean people don’t undertake those investments - but it does put a light on the mechanisms behind investment and how other policy settings support innovation.

If the concern is innovation spillovers, the natural response is not a blanket discount for all capital gains. It is targeted support for activities with spillovers, such as R&D, early-stage innovation, or commercialisation. If the concern is the normal return to capital, the natural response is expensing, loss refundability, or a normal-return allowance. A broad CGT discount is a very blunt way to address all these margins at once.

Importantly, such a design doesn’t necessarily raise lots of government revenue directly - it works by increasing the integrity of the tax system (i.e. preventing people ex-post reclassifying income just to lower their tax bills). Higher general tax rates do distort choices - the goal here is to broaden the income tax base, to allow for lower rates to raise a given amount of government revenue.

You do realise people can move don’t you

Nice yeah, capital mobility. It is an important topic, and the decision about where to locate is a big big part of the reason for tax competition between countries - driving down corporate rates and the tax rate on forms of capital income that seem especially mobile.

This isn’t just about people leaving. Imagine that no-one leaves - we might think there is no problem. But it may instead be the case that other prices in the economy adjusted, such that the founder that may leave still had the incentive to stay (keeping their post-tax return fixed by increasing the needed pre-tax return). A key margin here could be lower wages for the people that work for this entrepreneur.

For this reason the topic of capital mobility should be taken very very seriously. I agree!

But why do we see high paying, large scale, entrepreneurs in California (where the State plus Federal CGT comes to around 33%) and Denmark (where the CGT is 42%)?

Such locational investment decisions depend on amenities/infrastructure, available workers, trust in the rule of law, the depth of capital markets, and location to customers.

A founder looking to sell a solution to Australian customers won’t have that much of an incentive to leave. An entrepreneur that has connections across Australia would be stranding that capital if they left. And the infrastructure that taxes pay for alongside the regulations that encourage workers to invest in skills and stay in Australia produce the labour force they can use.

Are these policies around such regulation perfect - nah. But it is this ecosystem of policies, not just the tax rate, that influences these decisions.

And this is what is key. Ideas (and financial capital) are mobile but location specific factors are immobile. Wildly innovative global product ideas based on an incredibly innovative founder could move with them. The main game in town - improvements in the quality of provision to Australian customers - will not move.

Yes, if Uber gets started in Australia it will probably head to the US - and it would with no CGT. A2 milk left New Zealand to set up in Australia, even though this may significantly worsen its tax position, because of access to capital markets and pools of talent.

If we want to get around this, we probably need to think about 300 million Australians ….

So you don’t see any issue with taxing entrepreneurial income like wages?

I write this blog to ensure that no-one is ever happy with me. So trust me, I do have concerns to note.

I have no issue with the principle of people paying tax on their additional ability to consume - if I have the ability to consume more, sharing some of that with Australians to make sure social services run is a ok with me.

And as a fairness principle the idea that two people who can now consume more - but have achieved that in different ways - should pay the same tax. They have the same ability to pay.

But indexation alone likely overtaxes capital gains relative to labour income (I say likely as capital gains benefit from “deferral”).

In a submission on capital gains tax I was among authors suggesting a return to indexation. But we did put a couple of things around that:

One was an inflation allowance for other capital income. Another was income averaging. Income averaging is simply the idea that you pay tax as if you earned the income every year you held it - instead of pretending you earned all the capital gain in the year you sold. You still pay the tax when you have the cash (this is not a tax on unrealised gains), but it just changes the tax rate you pay.

The submission itself was mostly about income averaging, as the progressive tax system means lumpy income is taxed at higher tax rates than consistent income.

When looking at certain shorter held housing assets this was more than unwound by “strategic timing” of realisations. However, this made the case for averaging even stronger - not only does it make the taxation of capital gains more like labour income, it reduces the incentive to artificially “time” sales.

The problem here is that indexation alone does not treat capital gains like wages. And this issue is largely about those with “modest” capital gains like the individual at the top of this post - not the examples of people receiving $50m in 10 years that we’ve seen in the media.

So otherwise good?

A lack of averaging does concern me. But what else keeps me up at night when thinking about this topic:

1. Without averaging the tax rates are potentially quite high (although still comparable with Denmark - but without the structure of the flexicurity model behind it that supports this) - this makes the use of current empirical evidence a less strong guide that there won’t be enterprenerial responses.

2. Imputation can have interesting effects here with credits acting as an asset that generates additional capital gains, which may create issues with entities with significant retained earnings - this in turn could make getting additional equity investment costly depending on how this is treated at the personal level as a tax event.

3. The inability to claim capital losses becomes a greater issue for investment the higher the tax rate is.

4. The progressive tax scale reintroduces concerns about the taxation of risk - as good and bad outcomes are taxed differently.

With the first of these issues there has to be a policy call based on imperfect information. If the changes to immediate expensing, R&D, and other corporate changes are able to “remove the taxation of the risk-free rate of return” and “improve new firm liquidity” the high capital gains tax rate becomes much less of a concern - as if investment incentives can be maintained (for the marginal investment) this increasingly looks like a tax on “rents” only.

With the second one I have an unpopular view that the double-taxation of retained earnings is a category error, as it should be capitalised in the price of the share sale (given the buyer will eventually pay a dividend and there will be a capital loss they can claim).

With the third, I think we should generally have a system where losses are cashed out in general. I think the anti-avoidance rationale for not allowing the cash out of tax losses is a relic of the 1980s. So this should be in general discussion.

The fourth is an important point - progressive taxes redistribute income, and in turn reduce risk taking. This is a subtle result, but it does suggest the increasing progressivity in the tax scale since the 2000s in Australia may have implications for these same issues.

This is also broader than just entrepreneurs who intend to sell their asset. It also influences incentives for those who intend purchase and hold a company while undertaking “internal” entrepreneur. Furthermore, it influences investment in human capital.

In all these cases a high top income tax rate that comes in at an internationally low level discourages investment in things with uncertain payoffs. In this case the motivation to cut the top tax rate isn’t about entrepreneurs alone - it is about how all individuals are discouraged from taking risk due to progressive taxation.

This is a lot of concerns isn’t it?

Not for me. But it could be for you.

Give me any tax reform and I’ll write a million potential concerns - given no reform I’ll write another million concerns about no change. The fine people at Treasury and the ATO already know all this, and will talk through their own read of the evidence and why such a tax reform is appropriate.

My read is that replacing the CGT discount with indexation is defensible, including for founder gains. For founders with near-zero cost bases, the discount is not compensating for inflation, it is exempting part of a real gain.

But indexation is only a response to inflation - not other rationales for why there was differential tax treatment. Without income averaging, moderate founder gains can be taxed more harshly than equivalent income earned steadily over time. Without symmetric loss treatment, the system taxes successful risky projects more fully than it supports failed ones. And without careful interaction with imputation, expensing, and R&D policy, the system may still create avoidable distortions that prior policy makers were trying to address indirectly with the discount.

But let’s be serious here. Every second article in the AFR is complaining that tax rates are too high for someone - the wage earner, the entrepreneur, the housing investor. In every case people are certain they should be paying less tax.

But what government spending are we going to cut. Even after the upcoming cuts to the NDIS budget balance will rely on tax rates staying at current levels. At that stage where do you think we, as a community should be contributing less through our taxes?

I get it, it is nice to have more disposable income. But it is also nice to have a functional society where the most vulnerable are looked after, and public services are sufficiently funded.

Look I hate it when people say we should arbitrarily “soak the rich” to achieve this - extractive policies are a sure way to destroy wealth, discourage people from taking risks they would have been willing to take on in the absence of tax, and undermine social cohesion. People have a right to accumulate significant savings if they wish.

But asking that everyone contributes in proportion to their income, and that those who earn the same amount pay the same amount - that isn’t being punitive, it is being equitable.

The fact that someone makes a profitable business isn’t a “spillover” on others that warrants a subsidy - and on the face of it there is no benefit from incentivising risk for the sake of it. If a person would choose a safer activity in the absence of taxation, encouraging them to take risk is a distortion - not a good thing.

If the concerns I note above aren’t addressed I’ll complain about them - I always do. But we really don’t know what the policy is until we see it, and we know how the tax, the scope, and the definition of cost base will work on Budget night (or if there is only consultation, then after consultation).

But the idea that this will lead to an apocalypse is over-cooked.

I am not a monetary economist, and if you want to hear from an expert about Australia go listen to my boss Gianni La Cava on the ABC.

But I like to talk frameworks. And in order to maintain social cohesion and make sure policy makers internalise what concerns Australians it is important we discuss “what a supply shock is”.

My concern is that there have been a flood of articles not interested in doing this, but instead trying to use a crisis to demand the attention and policies they want - and state that anyone who disagrees has a vested interest.

The key thing is that, in order to gain the influence they crave in their bones, people arguing in “us vs them” narratives are undermining social cohesion. This is a line I strongly believe economists should not cross.

The best antedote to these bad faith arguments is to try to understand the difficult situation faced by the public - and policy makers - and thereby think about the hard trade-offs being faced when making policy choices.

And if you are an economist or commentator who wants to defend the nature of one of these arguments because you like some of the policy conclusions - where the authors triggering this post are explicitly saying there is a secret group of self-interested people in the background pulling the strings - you should reflect on yourself.

The public deserves to receive advice from people who try to understand reality and don’t peddle in conspiracy theories.

So back to the point, a supply shock means something bad has happened such that there is less stuff to go around right now. Government policy determines how that burden is shared, and aims to do this in a way that is publicly acceptable while minimising future costs.

You are an RBA apologist. They shouldn’t have hiked.

Mate, I have nothing to do with the RBA - if their decision was unhinged from economic frameworks I’d gladly drag them through the dirt.

The issue is that the RBA is being criticised for hiking during a supply shock in a way they can’t publicly respond to directly.

The Bank cannot say that they would “look through” a supply shock, but had to increase rates because inflation was rising prior to the shock - as if they explicitly admit to looking through, they would be worried a bunch of dumbasses would write in the media that the RBA is no longer credible.

I’ve spent time talking to central bankers during supply shocks a few times - especially as I was doing media/forecasting in New Zealand when a number of these shocks happened (pre-GFC oil price shock, GFC, Euro-debt crisis, and Christchurch earthquake), and was within the public service during COVID.

There is a consistent framework that has been applied successfully by central banks during these shocks (where success is about maintaining inflation expectations and limiting the increase in unemployment).

We can think about a negative supply shock as an anticipated jump in the price level alongside a reduction in the productive potential of the economy. The war in Iran is currently a temporary supply shock, so in the future oil prices will come back down.

Largely a central bank would “look past” such a shock - as it doesn’t clearly change the medium term outlook for inflation. You’ll hear terms like “this isn’t inflation this is a relative price shock” or “this is an increase in the price level, not the rate of growth”. So this alone doesn’t mean anything for interest rates.

This tells us that, if someone says “the RBA is hiking rates because of rising oil prices” they are misleading you - either due to not actually understanding the issue, or because they have ulterior motives.

In fact, during 2022 central banks did largely look through the direct supply shock - just for public commentators to go ballistic at them. As someone who tried to explain it at the time, I saw how abusive comment sections became.

Whether interest rates should change during such a shock requires an understanding of where the balance of aggregate demand and capacity are following the shock. Given uncertainty around that no change in the path of rates is understandable for quite a large range of views.

There are reasons why the central bank may change rates relative to the path they planned:

1. Cut rates: Hightened uncertainty will lead to a sharper decline in private expenditure - so cut now. A good example of this is the Christchurch earthquake in NZ. (Note: COVID-19 also gives a good example of this as discussed here.)

2. Increase rates: Inflation expectations are poorly anchored, as a result the central bank needs to response to the increase in the price level to prevent this driving up inflation expectations. A good example of this was also how NZ kept interest rates high after Bear Sterns failure.

Sorry all my examples are from NZ - given experiences I feel a bit more comfortable using those examples :)

Reading the RBA statement you can understand why they’ve made the decision they have - inflation has been accelerating, they believe that inflation expectations have been creeping up, and in the absence of the shock they would have been increasing interest rates to restore balance.

What is being said here is that an increase in interest rates is the response to aggregate demand rising above the capacity of the economy.

Putting this together, the shock just didn’t lead them to change the path they were on. It was debated, because of uncertainty. And you can bet there will be a lot of work to think about what the next steps will be - and what data outcomes would lead to different choices.

And you know what, the RBA will be wrong ex-post, but it is likely they will be assessed as right given the ex-ante balance of risk. Maybe rates needed to go up faster, maybe rates needed to be held or cut - but ex-ante there is significant uncertainty and they are making choices that balance these risks.

If something goes very wrong, the RBA will turn around an intervene. A slightly higher cash rate does not influence this at all. This will not make the decision to increase when they did wrong.

Increasing interest rates isn’t going to do anything about the price of fuel.

Sure - I’m not going to make some argument about a higher exchange rate reducing the price of oil in Australian dollars, because I think the argument in this title is largely right!

But the interest rate hikes aren’t supposed to do anything about oil prices - this is a false objective. Interest rate changes are really aiming to manage inflation expectations, and thereby medium term inflation outcomes.

Distributional consequences given the shock depend on fiscal policy - and during a supply shock fiscal policy choices are incredibly important.

The RBA is responsible for inflation and aggregate employment by managing aggregate demand. But high oil prices interupting supply chains will generate some dislocation in employment, higher costs for consumers, and provides a real role for the government to support households through this shock.

Now this is the thing. A lot of economists - including people like me - will critique fiscal choices around deciding on the distributional impacts of the shock. But ultimately we have to be honest that fiscal authorities have a very very hard task here - and they are trying to balance a lot of challenging objectives regarding how to share the burden of this shock.

So maybe we should try to be constructive in this process.

To help them do this we have to be honest that there is a cost due to the shock that they are trying to share. The government can’t magically make it disappear by “unlocking productivity”, “slashing benefits”, or “soaking the rich”.

The supply shock is temporary. As a result, there is no reason for large structural policies directly in response to it. I realise every commentator and their dog will use a crisis to say “look, you see we should do my personal thing” - but that is not the case.

A temporary shock doesn’t make your personal views about the structural economy suddenly more true.

Let’s think specifically about an oil price shock. The price of oil is higher because it is more scarce. There are two groups we may then want to support that don’t necessarily fully overlap:

1. Making sure the most vulnerable do not end up in a worse situation due to the shock.

2. Supporting those who are more exposes to oil relatively more, because they hurt relatively more.

An excellent article from Aditya Maitra at e61 describes this with respect to a petrol price shock, and highlights that price interventions are problematic and that income support for low income households appear most appropriate.

Different values may change the way we may want to support households, and those values are represented by the government of the day as the representative of society at large.

Questions that will come up:

• Is the saftey net fit for purpose as a way of automatically supporting individuals and households due to cost pressure and job loss?

• Can we shift the cost of this shock into the future by borrowing to provide households transfers now?

Government spending programs then come from looking to plug gaps in the former, while asking how fair we believe it is to shift these costs through time.

And the nature of the cost remains open. Nominal oil prices are lower than in June 2008 or 2022 (meaning real prices are even lower). Although energy consumption is still very oil intensive, electricity generation has become less oil intensive - suggesting that economic exposure may be weaker than during other shocks. And export prices have either held up (i.e. Iron Ore) or surged (i.e. Coal).

Lets be prepared for risks, but lets also keep some perspective.

Summing up

An oil price shock doesn’t mean we should suddenly slash the NDIS or increase the tax rate on capital gains.

Instead fiscal policy should be focused on specific distributional concerns, and targeting those to ease the cost of the transition out of this shock.

This is the same framework applied in 2022, which did limit labour market costs and helped those with low incomes. However, it still hurt for most of us because it was a shock which meant there was less stuff!

The decisions made ensured that the costs to the most vulnerable in society where contained - yes even if it meant that middle income Australians ended up paying higher mortgage rates.

It would be nice if some of us economists actually talked about these trade-offs, and pointed out the positives as well as the costs.

Right now, the army of people working at the RBA and within the Federal government are grappling with these questions - and are likely doing a better job of understanding and making decisions to help Australians than any of us public facing economists throwing rocks from the outside.

Perhaps it would be good if economists in the media took their role seriously and tried to share information with the public, instead of chasing headlines by telling people they are victims of a made up cabal of individuals who control the world.

With the Senate Inquiry report into the Capital Gains Tax discount coming out tomorrow I’ve been hearing a lot of people tell me we tax capital income at “too low” a rate, and that it isn’t fair on wage earners.

As someone who isn’t Australian this doesn’t immediately make sense to me - just like the way sandals are called thongs. Australia taxes a nominal dollar earned on capital income at full rates on a “comprehensive” income tax scale. This differs from most countries which tax capital income at a separate - lower - rate.

This suggests that something is missing. Either most countries in the world are owned by a cabal of capital owners unfairly making workers pay for government services - or there is a fundamental misunderstanding regarding the taxation of capital and labour income.

You’ll be shocked to know I think it is the later - let’s go on a journey to discuss why.

What is income?

This blog already covered that, so I’ll aim to summarise.

Cliff notes are that “income” matters in so far as it allows you to consume. As a result, we need to be thinking about income in terms of the consumption possibilities it provides.

This is important - we have a background principle for an income tax of equal sacrifice where we are thinking about people in similar situations sacrificing similar amounts of consumption in order to fund government services. In all of this discussion this is a central principle.

To keep this simple to start with lets think about the idea that the price of things goes up over time. As a result, $100 now may buy you a bunch of stuff but $100 dollars in a year isn’t going to buy you as much. This is inflation.

When you receive capital income part of this is compensation for inflation. What does this mean?

Well, capital income is a return paid from a stock of assets - you might have a term deposit that pays interest, bitcoin that generates a capital gain, or shares that give you some dividends. In each case the capital income you get is some return from those assets (or what economist call a return on savings).

You could use these assets to buy stuff right now. If you do, great. If you don’t then you receive capital income in the future. In the future inflation has happened, and so the value of your assets in terms of consumption will have declined due to prices rising.

Your capital gain, your interest income, your dividend - each of those is in part compensation for this loss in value.

So if you earn $100 of capital income in a year, part of this represents compensation for the fact that inflation has eroded the value of your assets. This is not income in the consumption sense discussed above, as you require that return in order to consume the same amount from a sum in the future.

This inflation logic does not hold for wage income. Your wage is compensation for your time - the value of your time doesn’t decline with inflation.

Instead when we get worried about inflation for wage earners it is really about capital income (or bracket creep - which is a separate topic for another time, and which also hits capital and wage income the same way). If you earn a wage and then don’t use it to spend immediately, inflation will start eroding its value. But that wage you haven’t used immediately is now savings, which is generating capital income that in part is compensating for that inflation!

And if you do earn a wage and spend it immediately, there has been no inflation - you sold your time, got a wage, and spent it. No prices changed.

Can you use this in an example

I’ll use the example we had in the e61 capital gains submission, because then I can use the same R code I already have and don’t have to do any work.

Take someone who is like an average full-time worker in Australia. So they earn $100,000pa. Nice!

Under the current tax system the the wage earner pays a tax rate of 22.8%. Very good.

Now what is the tax rate on equivalent capital income?

Remember, we can’t just take $100,000 and pop it into a tax calculator to make sense of this. The $100,000 includes the loss in value of assets due to inflation, so we’d need to take that out.

Say that you were holding a term deposit for a year and consumer prices went up 3%, while the term deposit paid an interest rate of 4%. Three-quarters of the interest income was just compensation for inflation.

In other words, $100,000 of interest income is really only $25,000 of real income that can be used to consume, the other $75,000 is needed to maintain the value of your savings.

Currently the nominal term deposit is taxed like wage earnings, so the same 22.8% tax rate would be applied to $100,000. Which means a tax rate of 91.2% on $25,000 of interest income.

So a lot of people would see the tax rate is the same on $100,000, which sounds fair. But if we “treated the term deposit income like wages” then someone only earning a quarter as much as the wage earner would face a tax rate that is 4 times higher!

Ouch.

To compare two people in the same actual circumstance, you would need $400,000 of nominal interest income to have the same real income as the average full-time wage earner. And the tax rate for this person earning from a term deposit would be 154% compared to 23% for our average full-time wage earner.

Man, that sounds pretty horizontally inequitable. And that is the current tax treatment of term deposits in Australia.

Tax rates on term deposits are absolutely insane, but other capital income is “concessional” right? Well lets do this on capital gains where there are large allowances.

Take the same 4% nominal 1% real return. $100,000 of capital gains is still $25,000 of income. Even with a 50% discount it is being overtaxed - as it will be taxed as $50,000 of income leading to a tax rate of 26.2%.

Interestingly, the steep nature of the progressive tax system around this level of earnings means the average tax rate doesn’t sound too crazy. But remember that someone earning the same $25,000 from wages is only paying a tax rate of 1.6% - which is a lot lower than 26.1%.

So in low real return world, the capital gain is being taxed at 26.2% vs wages at 1.6%.

If the nominal return went up to 6%, the discount equalises treatment with wages - $50,000 of wages and the $50,000 of real capital gains are now both being taxed at 13.1%.

In the “discount is right” world, both wages and capital gains are being taxed at 13.1%.

If the nominal gain goes up to 8%, then there is $75,000 of income being taxed like it is $50,000 - so here the tax rate on capital gains drops to 8.7% while the wage earner would pay 19.7%.

In the high real return world, capital gains are taxed at only 8.7% while an equivalent wage earner is paying 19.7%.

We can do a bit better than calling things concessional. Instead the current CGT discount is just a clumsy way of trying to deal with a problem in how we tax all capital income. The solution isn’t to increase taxes on capital writ-large, it would be to tax them like the actual real income they are.

Which in many cases would reduce the amount we tax them - especially for those who aren’t able to make use of trusts and other entities to shield themselves from taxation.

When talking about “comprehensive income” we are talking about real income. This isn’t taking the nominal flow and dividing it by CPI, it means actually understanding how inflation interacts with the value of net assets and providing appropriate compensation.

As a result, the idea that capital earners are all being treated concessionally is rhetoric - not reality.

But I’ve seen a lot of income distribution graphs that show this is a problem

Surprisingly, even very good economists seem incapable of following the economic definition of income when drawing income distributions see here, here, and umm me.

In the defence of all these economists the reason is that either we are trying to ask a different question (i.e. PSZ and AS are focused on national account equivalents, not economic income measures), or we don’t have the right data to “inflation adjust” capital income - and are talking to an audience the takes that into account when looking at the numbers, while filling notes with health warnings.

Recently researchers have shown that such estimates are possible given microdata, and that it does change how we view the income distribution.

And maybe the communication based on less complete measures has sometimes been a mistake - especially given the completely incoherent way that Gabriel Zucman now publicly talks about the distributional figures when misleading everyone he possibly can in public about income and wealth inequality.

The structure of the CGT discount does mean that there are individuals that can take high risk plays that are subsidised by the tax system (or ways of shielding wages as capital gains to reduce tax treatment) - a point Greg Kaplan noted when stating that you don’'t get rich from working for someone but from capital gains.

So this is not to say there aren’t mechanisms leading to undertaxation at the top. Instead we should be trying to understand those specifically and clean up the treatment - and not doubling down on overtaxing the majority of taxpayers when they try to save just because of vibes.

e61’s recommendation around capital gains taxation (which I was involved in) would lead to more neutral treatment and raise more revenue - however, such reforms should be part of a more comprehensive discussion about the capital income tax.

All this is at least a world away from saying that capital income as a whole is undertaxed.

Cool, adjust for inflation, got it

At this point I am certain there are a number of public finance experts shouting at their screen calling me a moron. Fair enough, lets discuss why.

Remember how we were talking about the idea of shifting consumption through time. And then we jumped to just talking about prices. Well, a return on capital income is in part compensation for deferring consumption - which isn’t just about the fact that prices rise.

Instead keeping the present value of an asset unchanged requires compensation based on the discount rate that individual holds. When discussing tax policy this is often termed the normal rate of return - or the return that is necessary for the individual to be indifferent between saving through that investment or not.

The normal rate of return will include inflation, but it also includes time preference, compensation for risk, and other factors that may influence the opportunity cost of saving.

In most circumstances an allowance for the normal rate of return will be larger than inflation - but it is difficult to know exactly what it is. Policies that automatically exclude the normal rate of return (such as the GST) are especially attractive as a result.

But rents!

Man, Australian’s love going on about taxing economic rents almost as much as they enjoy overdesigned regulations. You’ll be surprised to know that non-Australian’s have also read Ricardo, Marx, Henry George, and taken first year economics classes.

And the interest in understanding these shows some wisdom - but if we aren’t careful it can lead to some pitfalls!

The taxation of an economic rent involves saying “we can tell you receive a higher return than you need to make that choice, so we will take some of it and that will be efficient as you won’t change behaviour”. This argument is completely right.

And it tells us there are two margins we need to think about and be clear on whenever implementing a tax based on an economic rent:

1. Have we identified a rent, and hence an efficient response to the tax (or is it instead a return necessary to generate long-run investment).

2. Do we view it as equitable to ask that individual to sacrifice more in order to fund government services.

For this reason, rent taxes should be operationally separately from an income tax. They should definitely be in the tax system - and they should be voted on, discussed, and evaluated. As the key limiting factor is about the equity of asking certain individuals to bear the burden of the tax the normative aspect of discussing this with the public is very very important.

Let’s use the example of a land tax. If we imposed a 90% land tax this would be capitalised in the price of land. The entire burden here will fall on current land holders, as people will only purchase the land if the price they pay incorporates the present value of future taxes.

That is cool, no behavioural distortions, and a clear group who bears the burden of the government funding instrument. Do we think it is fair to ask that group to sacrifice a significant amount of their own consumption?

I don’t know, that is sort of a conversation for people to have. And often it is voted against as a lot of the public disagrees with such policies on fairness grounds.

So when we put it that way, in what universe should we be trying to implement a “land tax by stealth” through other tax instruments (i.e. fiddling with the structure of the income tax)? This is wildly undemocratic and suggests that individuals who think this is a fair change are either out of touch, incredibly bad at persuading people, or don’t like the idea of people disagreeing with their values.

I say this as someone who, in my younger years, would go on and on and on about a land tax to fund a UBI in the face of technological change - one of my bosses explained to me that a lot of people disagree on the equity implications, and if I can’t internalise that I sound like a dork.

So I’m all good with people advocating for specific economic rent taxes and making that case - hell yea, go for it. But lets keep this separate from discussions about an income tax that has a coherent visoin of taxing consumption possibilities the same way. Mixing them risks making the income tax harder to operate transparently, and may inadvertantely force a tax change that people in society actually don’t want.

If you can’t do this because you know it is right, remember that you are probably talking more from your personal values than from an objective reading of the evidence - and people are actually allowed to disagree with you on value questions irrespective of how many economicsy words you use.

So let me share to good word with you.

So let me talk about what this calculator is, what it isn’t (no don’t use it for refunds), and why we’ve released it.

Note: Tax news has been raining as nectar from the heaven and people have politely asked me for views I haven’t provided - I’m sorry and I’ll try to catchup when I can!

Tell me why I should care

You are a single parent living in the suburbs of Sydney. Both your children are at primary school, and you are trying to work out the balance of work shifts and spending time with your family.

In this world you are interacting with a complex set of payments, payments that reduce as you earn more. Such “abatement” reflects a tax that in turn decreases the wage you receive if you take on more responsibilities at work or decide to work a bit longer.

This intensive margin incentives are reflected by a concept called an Effective Marginal Tax rate (EMTR). This calculator works out these EMTRs for an individual with given characteristics, and illustrates them - along with some hidden information that indicates what drives it all.

Now the audience for this product isn’t the single parent. I would love them to play with the calculator and tell me how it reflects - or doesn’t - their lived reality. But in truth they are living that reality, and making the best of the hand they are dealt by nature, society, and the policy choices of government.

Instead the purpose of the calculator is to allow people who want to think about the implications of policy settings to work through examples themselves - and in turn understand how the system may be influencing choices to work and the opportunities available to people.

Got it, cut their benefit right

Mate slow down. The financial disincentive to work isn’t telling us benefits are too high - although that is a comment I hear. It tells us that the removal of these payments as people re-enter mean that the tax rate faced by low income earners can be very very high.

We could reduce these by pushing out abatement. But it would increase fiscal costs.

We could cut payments to reduce these effects, but it would push very low income individuals into even more precarious situations.

We are currently making tax rates high for low income earners to pay for the welfare system - or to “target need” and make the system more affordable. And a consequence of this is that part-time work becomes relatively less attractive.

The calculator isn’t telling us how to solve the impossible triangle. It is just reflecting its existence through these effective tax rates.

Why don’t you let me try out some different policies so I can solve it?

Originally Matthew Maltman and myself were keen to allow people to edit and change policies - and an earlier version of the calculator had this option. But we removed it for two reasons:

1. We want to continue development and view the calculator as experimental - the best way to do that was to provide the current system and take on useful feedback

2. We took on external advice that allowing policy change can be misleading without guardrails (i.e. warning flags, indications of fiscal cost)

Overall, we do intend to introduce this functionality in the future - but we want to do a bit more thinking, and talk to a few more people, before we do.

So if you have thoughts, feelings, comments, or questions please reach out - either on the post or through email.

It has been released with its scaffolding on as we are keen to take on feedback - although we’re confident we’ve got a lot right, it is still a work in progress.

Finally, an important point - this tax calculator views an individual as earning a stable income over the year. Income variability significantly changes many of these results, and makes such calculations significantly more complex. So keep this in mind when you think about what these results tell you.

Behind this was a great piece by Chris Richardson on tax reform, where he uses recent Australian evidence to say the case for a higher GST rate is overstated.

As someone who went onto the Business and said put GST up you'd think I'd argue with this. But no, the writeup is good and the work is well done and informative. I would go as far as saying it is an example of exactly what economics should be in the media.

So you'll think I've changed my views. No.

And to explain that, let me discuss what is missing from the debate.

tl;dr: Base broadening. A higher GST requires a broader base. Stop complaining about politics and let's get the tax system right.

I haven’t read it, what did they say?

I first spotted the article via a post from John Simon - before even opening the AFR. Then Chris’s article gave us this statement [Note: Both authors hint at base broadening as well]:

Now seeing this I had to hunt down the related paper by clicking the link in the article! And here it is by Jason Nassios and James Gieseck.

So what is going on here. There is a CGE model that has been set up to analyse the Australian economy. They then model personal income tax and GST in detail (capturing the gaps in the bases of both policies) and analyse the excess burden (think of it as the value of lost output) associated with increasing the tax rate of varying tax bases.

They find a couple of things we will focus on here:

1. The excess burden rises with the tax rate - confirming the discussion for Australasia from Creedy (2003).

2. At current rates the marginal excess burden from a higher GST rate is around the same as higher personal income tax rates.

So firstly, I’m glad they confirmed the results of probably the best tax economist from Australia-New Zealand. And then secondly, the case for just increasing the GST tax rate in isolation does look weaker.

But you promised me that GST was a more efficient base

True - you are talking about this post here right.

Comparing a broad-based consumption tax to a broad-based income tax an income tax will tax the normal rate of return. Because of this, consumption in the future is taxed more than consumption now - and this relative price distortion generates a bias to consumption now which is inefficient.

And Jason and James’s model includes this - that is part of the great thing about a CGE model!

Image source.

So if they have this income tax distortion in their model AND the tax rate on personal income is - on average - higher than the GST rate, then how do we get similar excess burdens?

The answer is the narrow consumption tax base.

Australia’s VAT Revenue Ratio (VRR) is 0.5, compared to 0.96 in New Zealand. This tell us that, due to exclusions and shifts in activity half the expenditure tax base isn’t being captured by GST.

Having some consumption items included and others not included also leads to a relative price distortion which has efficiency costs! The model is capturing that individuals will substitute between tax and untaxed items, firms will change what they supply, and capital will be inefficiently allocated due to this.

So this is telling us that the distortions due to gaps in the GST base are larger than the intertemporal distortion of taxing future consumption at higher rates.

And this argument has existed in the past - including in this influential piece from some IMF economists.

So your solution is just to broaden the base?

Yes. And then increase the rate because the marginal excess burden of doing so will be lower.

In other words, the marginal excess burden of base broadening will be LOW - it might even be negative. And once that has happened the curve in the paper will shift down, making a tax-mix switch a good idea.

No stop, such broadening is politically impossible

Sure.

I am not here to talk politics. I have neither the basic social skills or interest in wrestling with “political reality”.

I want to talk to people about how things actually are, and discuss the trade-offs involved so we can have the best policy settings in place for Australians.

You may be concerned about distributional effects, and I think that is an important concern that needs to be dealt with. I think it can easily be dealt with - but if that is your worry I need to make that case (which I haven’t yet but this and this do in part).

But if anything this recent work reinforced to me that GST reform needs to start with base broadening prior to increasing the rate - because the inefficiency associated with people changing their activities to avoid GST is greater than I’d realised.

Now lets not be abstract. Yes this means including fresh fruit and veges, yes this does mean including private schools, yes this does mean including healthcare.

And yes, this does mean we need to make some expenditures on income transfers and health to make sure the burden is shared fairly.

But if we believe this modelling tells us not to increase GST rates, it instead tells us we have to base broaden. You cannot take one of these conclusions and not the other.

So GST reform is still a major necessary reform if there is appetite for real reform in Australia.

However, I thought it would be fun to discuss a recent micro note that came out from e61 and the interpretation it is receiving - this note on effective income tax rates by Greg Kaplan, Matthew Maltman, and myself. An AFR piece did a good job of positioning this, and Greg’s speech, in the more general discussion around tax reform.

Note: The tax reform roundtable was fun - e61 CEO Michael Brennan also shared a lot of insights based on areas e61 has been thinking about around bracket creep and the State-Federal nexus. When it is available I’ll share links to all the speeches here.

Now I’m going to give you my own view - so if you disagree with me don’t blame my amazing co-authors, as I’ve probably said something dumb or purposefully inflamatory. So lets do this.

tl;dr Taxing income consistently is good and fair. We all need to step back and view government finances - taxes and spending - holistically. Ad hoc hyperfocused interest group based policy making might be good politics, but it is bad for Australians.

Why do you guys want to tax capital gains at full rates?

Why are people saying this? The note, and Greg’s comments at Allegra’s roundtable were quite clear - we should be treating all sources of income consistently irrespective of their source. And we don’t.

This doesn’t necessarily mean taxing capital gains more - it could also mean taxing other capital income less. The main thing is reminding everyone about principles of vertical and horizontal equity, and taking about the myriad of ways (deductions for charitable giving, capital gains discounts, subsidising superannuation) we have moved away from that.

Varela, P., Breunig, R., & Sobeck, K. (2020). The taxation of savings in Australia does a great job of showing the inconsistency of how this works for savings - our charts merely reflect how this then shows up across the income distribution.

So what did you do?

The exercise we showed is part of a deeper project where we are trying to understand effective tax rates in Australia. Although I could cite a number of big authors with publications in great journals to motivate this I want to mention less publicised work that I believe gives a better and clearer path to practically doing this - New Zealand Treasury work on Effective Tax Rates.

When digging into the weeds there are things I disagree with on their treatment of income and tax, as the author will be able to tell you. But the broad principle and structure is strong and pulls us to the question of asking what income is.

So what is income? Income is what you can consume now. Sounds easy. It is not.

If your super balance goes up is that income?

If the government commits to pay a higher age pension in the future for you funded by others is that income?

If the government gives you a benefit and taxes it, is that whole amount income?

If you sacrifice a dollar to save and inflation occurs, does this subtract from income?

How we answer these questions influences how we measure income.

We take small steps towards a more comprehensive measure of income than “what is taxed”. To do this we:

• Add in the discounted component of taxable realised capital gains.

• Disallow deductions that aren’t associated with generating income - viewing them as consumption.

• Add back in voluntary superannuation contributions.

Each of these changes is consistent with the way the current tax system operates - so we aren’t going to some extreme associated with “economic income”, or saying that your leisure time gives a value that should be taxed. Just adding in some of the low hanging fruit that is “of the nature” of the way other income is taxed in the tax system.

And that gives the following:

A progressive tax system, where there is growing differences in the spread of tax rates in later percentiles - akin to the discussion of horizontal inequity in Herault and Jenkins (2024).

But whether something is really “horizontal inequity” depends on whether we are really comparing people in similar situations.

When we look at this spread a lot of it is driven by family structure (tax offsets, medicare levy, non-taxable benefits) - while at the top the spread in such taxes is due to the differential treatment of capital gains and deductions for charitable giving and voluntary super contributions.

The former suggests that individual income is a poor reflection of needs based targeting in the tax system - the later is closer to true horizontal inequity (or treating people in similar circumstances differently).

No but inflation, and we want to encourage charaties, and …

Great stuff. You’ve identified that the tax system is inconsistent in how certain things are treated - which means the ability to organise around this inconsistency can lower someones tax rate without changing the substance of what they are doing.

Wait, that wasn’t your point - ok let me run through this.

I don’t disagree that inflation isn’t income. In fact I agree!

But we tax the inflationary component, or more broadly the normal rate of return on all capital earnings. As a result, the tax system biases us to consume now rather than to save and accumulate earnings.

The taxation of capital gains at full rates is equivalent to the taxation of accumulating interest income at full rates.

In both cases, capital income is overtaxed. The issue is that we are choosing to (excessively) correct for it for one capital income item - and not for others.

Asking for consistency isn’t saying overtax capital income more - it is saying make sure we are taxing such income consistently. If we decide we should remove the inflation component for one type, we should do it for all types.

And on charitable giving lets keep something in mind - we might want to subsidise activities we view as “good”. But these should be treated like any other government expenditure, and evaluted through the same process. Not slid into the tax system to lower “compliance"/oversight.

Otherwise it stops being a reflection of the true social will regarding what is good, and just a means for interest groups to poke holes in the tax system in order to protect their own interests.

So what is income exactly?

Yeah good question. As we said above, income in a period of time is what you can consume. The idea here is that you have an ability to pay that occurs when you have the option to consume the income - and that in turn reflects when you should face the liability for the tax. Taxing this income at a different time is then similar to taxing the income as a concessionary rate - as you receive the time value of deferral.

For actual measurement there is a nice paper from 2001 that discusses concepts of income with respect to household surveys - concepts that are super important for people working with national accounts and income distribution figures.

Lets look at their table:

The income concept used in the note is someway to Gross Cash Income - which is the hypothetical tax base which is adjusted in comprehensive systems, like those in the US, Australia, and New Zealand. This is different to the taxable income as we retain amounts that we deem to be income even though they are adjusted out of the income tax base.

So what exactly do you want us to do!

Well before we say what to do I want to make sure we agree on the principles.

The habit for policy circles in Australia to demand “practical solutions to the problems we know exist” - without having done the framing work to understand the problems, principles, and trade-offs - makes me extremely angry.

Demanding practical solutions immediately doesn’t make you smart, it makes you do the type of dumb stuff that breaks policy and makes things harder for future generations. If this statement upsets anyone please highlight this in the comments or via email, so I can repeat myself directly to you.

But assuming you’ve now bought into the principle of equal treatment we’ve discussed what are the policy levers to look at:

1. Broaden and increase GST - this does not tax that rate of return, and treats consumption through time the same way. (Fair enough if you are concerned about regressivity here - I’ll come back to this in a future post. But first I’ll do a post about Chris’s discussion of excess burdens later this week - neat paper here that he is discussing)

2. Adjustments to capital income that only taxes the real rate of return (i.e. dual income tax system, ACE).

   1. Relatedly, clarifying the demarcation between capital and labour earnings.

3. Then remove the random capital income subsides around the place.

Things like trusts I find tricky. My understanding if that the benefit of trusts stems only for the ability to “spread” income among multiple people - so it is a function of the progressive scale. This income splitting is definitely tax minimisation, but it also raises the issue of whether it is the individual - or the family - that reflects the right unit of analysis for our tax system. Would be interested in more reading on this to understand the scale of the concern!

Why aren’t we worried about inflation and labour earnings? That is also an interesting question. The idea is as follows - when you sacrifice the use of a dollar, inflation reduces the real value of that dollar and you require compensation to maintain its value. Therefore there is a stream of nominal income for capital that isn’t about consumption.

When you earn labour income you are sacrificing the use of time. Time is a real not nominal economic variable - so the value of time is invariant to inflation.

Now a very fun implication of this is that there are capital gains generating activities that are “more like labour income” than bank interest - i.e. renovating a house, building up a small business and not paying yourself wages. These do not need compensation for inflation … and so there is a bias towards doing these instead of spending your time as a wage worker.

Wait, you want to increase taxation on wage earners?

Lets start from the start. If we want to maintain government spending as a higher percent of GDP we need to raise the revenue - if we don’t we could cut spending, but such cuts involve deciding where to reduce services. Calling the government a leviathan and pretending public servant numbers are to blame doesn’t help.

If we as a society don’t want to start cutting government services in health, aged care, and the NDIS, then the revenue to fund these programs needs to be raised in the most efficient way possible.

This likely involves more taxation of wage earners irrespective of how we do it. We have choices about where we put this burden (i.e. whether it falls more on high income earners), and there may be ways we will tax “economic rents” efficiently that can lower the burden a little (i.e. land taxes, wealth taxes, supernormal profit taxes). Furthermore, since some capital items are oversubsidised the case that these items are favoured while both labour and other capital items are not may still hold.

These are debates people can have.

But having a principle that anything that taxes capital more is the solution - when the inflation component of capital income is not income - is bad policy and bad economics.

So if we want an efficient tax system, and we want a larger government, we’ll all have to pay a bit more ultimate tax on our labour earnings - either through income tax or through GST. And when we do this we want the burden to be fair - people who struggle need to be given a fair go of it.

There is no money tree of ultra wealthy people that can pay for everything we desire. And if you think that way you are delusional. I’m not here to feed your delusions - and hope other Australian economists wake up and tell the policy entrepreneur community saying this to live in reality.

The Australian people are adults, and we should be honest with them about these trade-offs. If we were, we’d likely find that they are a lot more comfortable with reform than a lot of the political junkies that dominate the airwaves.

We had a lot of fun and received some excellent questions. I went in determined to make my takes as hot as possible - and Lachlan and Steven made sure to bring in their own.

The mentioned policy trackers are here and here.

As you can tell from the chat, we aren’t going to show a preference for either major party - we believe both parties can show leadership and represent Australians. We just wanted to talk about economic things - and really focus on why there were so many pieces on fiscal sustainability in the past were (here, here, here, here, and here).

Well, talk about that and the unavoidables (election betting odds and tax reform).

I have had a lot of questions about this since though - specifically why we focus on “labour income” rather than income in general. So I thought it would be fun to discuss this below.

tl;dr

1. Do we want to reduce tax on the normal rate of return?

2. Do we want a one-off tax on wealth?

3. Do we see sufficient benefits in compliance and reduced evasion from a consumption rather than income base?

If so, we want to switch part of your income tax or a payroll tax into a GST.

Note: Steven wrote a great article in the AFR outlining some reform principles and practices for the tax system - I’ll probably blog about a few of the specifics on this in the future, and if you want me to try to twist his arm to talk about one of the topics comment below!

By your logic a GST is a tax on all income

Good point, I can see that if we take the narrative Steven outlined this seems like the natural way of viewing this.

However, a GST does not tax the normal return on capital and in that case it is often termed a “tax on labour” rather than a “tax on income”. In fact, for a tax economist a consumption tax is often viewed as *roughly* equivalent to a payroll tax - but with much better administration and compliance properties.

So how do we get here? A nice academic piece is this by Auerbach, the main tax review on this is this Mirelees Review (specifically the chapter on the taxation of household savings - rather than the consumption tax chapter), and the IFS Green Budget from 2009 is also pretty nice.

But I’m keen to see if I can explain it in my own way - so I hope this is useful!

Lets start with an example.

Imagine you earn $100 gross and you can either consume it now or in the future. You have a discount rate of 5% and can receive bank interest at 5% to compensate - we’ll call this the normal rate of return.

Furthermore, we will assume that the incidence 100% falls onto us for both taxes - so we end up paying the payroll tax (the gross wage doesn’t change) and we end up paying the consumption tax (the goods price rises by the tax). Given the equivalence we will find, we will expect prices and wages to adjust in a consistent way for both taxes - so this assumption just buys us some clarity!

If we tax gross payroll at 10%, then in the initial period you receive $90 and pay $10 in tax. You pop the $90 in the bank and earn 5% interest ($4.50) and end up with $94.50 to spend on consumption.

If we instead tax the gross spending on consumption at 10% (or a GST increase of 11.111% with lots more 1’s ongoing), then in the first period we have $100. We save it and get 5% ($5) giving us $105 to consume. But there is now a tax payment of $10.50, leaving us with $94.50 of consumption in prior prices … exactly the same!

So the key takeaway is that both taxes will end up with the individual consuming the same amount. A payroll tax will give us $10 of tax upfront, and lets the saver consumer $94.50 in the future, while a consumption tax gives us $10.50 later while allowing the same consumption. However, this higher tax payment for the consumption tax is simply the payroll tax with interest added - so in present value terms, the tax being paid and received by government is also the same!

What happens if the interest rate and the discount rate are different?

Nice question. In our example the discount rate didn’t matter until the end - the individual ends up with the same consumption in the second period in both cases. The discount rate we discussed is the social discount rate and captured when the government would prefer to have revenue.

But as soon as people are thinking about when to time their consumption this does matter - but the consumption or payroll tax treatment does not influence this!

At a discount rate of 5% an individual was indifferent between consuming now or in the future for both taxes.

With a payroll tax if you consume in the first period you get $90 of consumption. If you consume in the second you get a present value of $94.5 divided by 1 plus the discount rate - which is also $90.

With a consumption tax if you consume in the first period you get $90 of consumption. If you consume in the second you get a present value of $94.5 divided by 1 plus the discount rate - which is also $90.

If the discount rate declined then in both cases the person consumes in the future, if the discount rate rose then in both cases the person consumes now.

However, what happens if the interest rate is higher than the discount rate in terms of the value of tax and consumption paid?

Lets increase the interest rate to 10%. Here consuming in the second period gets you $99.

With a payroll tax the tax paid is unchanged - it is $10 in the first period. And the final period consumption is $99.

With a consumption tax, the tax paid rises to $11, with has a present value of around $10.48 with our 5% discount rate. And the final period consumption is $99.

What has happened here is that the individual is able to earn supernormal returns from their initial labour income. The payroll tax takes away these funds from the person, and so means that these “supernormal” returns cannot be taxed.

This is why we often say that a benefit of a consumption tax is it only excludes the normal return on capital - and still taxes supernormal returns (unlike a payroll tax). Note: It gets a bit more complicated here in terms of what is generating the return and the ability to scale up and down investments - but we don’t need that right now.

So it taxes more than an income tax

No no no.

An income tax will tax labour income. It will tax the supernormal return on capital. And it taxes the normal return on capital. Due to this broader base an income tax can be applied at a “lower rate”. But it also means that we start taxing consumption in the future more than consumption now.

Lets go back to our example with a 5% interest rate. An income tax will take the initial labour income and reduce it to $90 raising $10 of tax. We then make $4.50 of capital income from savings, which generates $0.45 more tax. In the end, we have $94.05 to use for consumption in the second period - compared to $94.50 in the case of a consumption or payroll tax.

If someone consumed in the first period, then they would receive $90. Using our 5% discount rate, in the income tax case the present value of consuming in the second period is now $89.57, which is less than $90.

So the income tax - due to the taxation of the normal rate of return - will make this person switch to consume in period 1 instead of period 2.

The key distinguishing feature between a flat income tax and GST is that the normal rate of return on capital income is excluded with a GST when with an income tax it is not - in both cases labour income is indeed being taxed.

This can change the timing of when people spend, and may seem unfair when two people with the same earnings capacity end up paying different amounts of tax just because of when they would like to spend.

What about labour supply

At face value there is no difference between a payroll tax and a GST in terms of labour supply effects - in both cases the value of an additional earned dollar is being taxed.

It may be said that a GST taxes the market value of consumption - even when it isn’t financed by labour income. So it may encourage participation from those with other income sources (i.e. government transfers, capital endowments). However, we need to be a bit cautious with this argument.

Government transfers are set up to provide a certain minimum level of income to people, so the participation response to those is due to the target level of income - not the tax treatment itself. If participation was being encouraged it would be because the real value of benefits have been cut. This isn’t about the GST switch, it is about not thinking about the tax-transfer system as a system.

On capital endowments it is true that a GST tax is a one-off tax on existing wealth. So we need to make sure our view on the participation effects of a one-off wealth tax and a GST are equivalent - and to be clear these are one-off effects, not flow effects over time.

Wealth tax?

Noticed all our examples took a person and had them initially get some income from their labour. But what happens when people have some initial wealth?

Say you have a net stock of wealth of $1,000 dollars. The price level suddenly rises. With that $1,000 dollar you can’t buy as much stuff anymore.

That is the one-off wealth tax of a consumption tax, nothing fancy.

No fancy statements about appreciation or depreciation of asset prices - the level of consumer good prices has gone up, without any improvement in firm profitability or returns to labour. There is no liability due to “holding” the asset, you just can’t buy as much stuff from now and for forever.

This additional one-off tax on wealth from the introduction of a consumption tax is a boon for government and has distributional consequences. I realise it is still popular to bash boomers - a view I don’t agree with unlike the many others my age - but the introduction and increase in consumption taxes has specifically redistibutioned AWAY from them.

Often when you hear people talk about not taking workers and instead taxing consumers the discussion is actually about this one-off wealth tax - shifting a tax liability away from income generated by current workers towards prior workers.

And these aspects are not irrelevant given the specific economic changes occurring (i.e. aging) - hence this transition should be considered on its own merits.

What is your point

We’ve had a whirlwind tour of consumption tax equivalences! Hopefully the examples were useful, but what is our key takeaway.

1. Payroll and GST are equivalent when individuals only receive a normal rate of return on assets.

2. Payroll and GST taxes differ in their treatment of “fixed” supernormal returns on capital (GST taxes them).

3. Income and GST taxes differ in their treatment of normal returns on capital (income taxes them) - this means that income taxes tax future consumption more than current consumption.

4. None of these taxes are necessarily “favouring” the treatment of labour at a given rate - instead the argument is about the size of the base.

5. GST adds a one-off tax on wealth into the mix - meaning that there is an intergenerational difference at the time the tax change is introduced.

So there are three key things to think about if we want to do a “tax-mix switch” from a flat component of income tax to GST (noting that the tax-free threshold makes this a little more complicated in Australia than in New Zealand):

1. Do we want to reduce tax on the normal rate of return?

2. Do we want a one-off tax on wealth?

3. Do we see sufficient benefits in compliance and reduced evasion from a consumption rather than income base?

People who recommend the switch generally support 1 and 3, and those that talk about intergenerational equity tend to think about the 2nd.

If you have any questions shoot below! And also feel free to call me out for anything I’ve said that is dumb.

We had a far ranging conversation on the nature of institutions and incentives, the role of bureaucracy, the collection and storage of individual data by governments, the impact of COVID on trust, regulation, and much more.

Note: I’ve been told that these podcasts can be hard to listen to through Substack, so here are a couple of other links that might help:

• Spotify.

• Youtube.

Chat structure and takeaway

The structure is 1/3rd introduction to institutions, 1/3rd examples, and 1/3rd on lessons from Australia about the size of state and community institutions - to follow Larry Summers rule of forecasting.

For those who have read Why Nations Fail and Narrow Corridor you will hear a lot of similar concepts, but John was sure to give an important Australian spin on issues - especially given the relative success of Australia when it comes to social trust and stability.

My key takeaway - Australia is a strong example of a country with high trust and strong institutions. But an increasing focus on winners and losers vs a shared experience based on principles of friendship would erode this.

Every one of us is responsible for this - our decisions determine the “air we breath” as John terms it, and our willingness to consider and vote on the basis of giving people a fair go (rather than our pocket book) is necessary for a stable and prosperous society.

And this is why economics is so important - although that final statement is probably just us ;)

Note: These are also the authors of Australia’s Pandemic Exceptionalism - so feel free to give that book a read, and shout out if you want a review or a podcast on this.

To warm everyone up, both Richard and Steven gave thoughts on “mortgage interest deductions for first home buyers”. Then Richard discussed his work on negative gearing and housing. While Steven talked about his proposal for a standard deduction for labour income.

In all three cases, both economists gave a full set of views about these policies, and why they agreed or disagreed based on a set of economic principles.

If you want to hear these views, give it a listen.

A key learning for me is that even when policy proposals sound fairly different (i.e. views on the treatment of negative gearing), the views are often based on a solid framework of taxing income types consistently - and the level of difference is much smaller than public discourse would make us believe.

If I had an extra hour I would have liked to test out some hot takes - if that is something you’d like to hear be sure to comment below.

Note: I’ve been told that these podcasts can be hard to listen to through Substack, so here are a couple of other links that might help:

• Spotify.

• Youtube.

Pelin Akyol talks me through her recent work on multi-choice tests, and shows me how much value economists have in working out the optimal design decisions around test design. When the paper is released I’ll link to it here.

But if you want the answers now, I suggest listening to the podcast - or reading the associated transcript.

I’ve been told that these podcasts can be hard to listen to through Substack, so here are a couple of other links that might help:

• Spotify.

• Youtube.

But as I recovered Lachlan Vass sent me this tweet:

What is going on here? Well tariffs leading to a destination-based cash flow tax was the first of my predictions for 2025, and potentially a better way of dealing with concerns around multinational tax.

This would involve having an import tariff (done), a relief of taxes on exports (discussed), and a change in corporate taxes within the country to be on a cash flow basis (who knows!).

Now this is probably too generous - I don’t believe that the US administration is playing 4d chess, and doing such a thing ad hoc is not ensuring that double-taxation is avoided and the tax is imposed consistently cross-borders. Specifically:

• The 104% tariffs are insanity, not just because there are inconsistent tariffs (between 10% and 100%) but also because it will directly generate significant economic harm.

• The US could legislate a DBCFT immediately - given something as insane as deporting US citizens and legal migrants to essentially concentration camps has support of all tranches of government, I’m sure the administration could actually just change corporate tax if they wanted to. They just need to make the DBCFT sound “masculine” and the child like US public and media will simply agree with it at this stage.

But a believable eventual outcome of all of this is a shift in the direction of the tax base to a destination basis - a final direction many economists support, even if it isn’t worth the US imploding its own economy for.

If you’re a New Zealander reading there is nothing to stress about - except for the messy global transition and likely recession due to current “US policy induced uncertainty”. I would recommend that NZ Treasury and IRD does give some advice regarding corporate tax reform in this new world though - as understanding how to work under different types of rule-based orders, and how to support them, will matter..

However, this would also leave a $62bn hole in the Australian tax base. Australia would lose taxing rights on “rents” associated with mineral products and financial services - reducing tax capacity substantially. This is a bit of a deeper concern.

The double-whammy of uncertainty and a switch to a destination basis is going to tear a hole in the Australian tax base - the first in the short-term, the second in the long-term.

Maybe it is even more important to discuss tax reform now.

At the time this came in I was in New Zealand - so I have no special feelings about the program. However, talking to Australians this policy holds an almost mythological place in the Australian COVID response.

So I have to give a content warning that I will be talking about this policy as an emotionally detached Kiwi - who believes the introduction, design, and exit from the equivalent scheme in New Zealand was arguably better. And where analysis of the scheme has been willing to be critical (with detailed independent economic analysis and CBAs).

Note: There are a lot of economic things Australia does better than NZ - hence why incomes are 30% higher - but let me claim something here.

But as this is a retrospective I also want to be clear - JobKeeper was a big plus in the context it occurred in. It was a brave policy that was a massive net positive during a time of great uncertainty, when it was unclear if other policy options were even possible/feasible.

Admiting that such a policy was done in a rush, and could be done better if we are willing to evaluate and plan for the future, does not undermine this.

So what are some lessons I think we’ve learned? I’ll list these below but remember this is just my view and arguments, others will have different lessons and may have better arguments.

If that is you feel free to outline them in the comments below. And I’d be remiss not to point to the series of Independent Australian reviews that have discussed this topic - like this one, and this one only on JobKeeper, and this one, and finally this recent book. I don’t see anything I’m saying here as contradictory to all of this rich work.

tl;dr Long post - so the summary lessons I’ve taken are:

1. When you use job retention schemes during a natural disaster type crisis, the benefit comes from moving quickly.

2. Have a clear exit. Once the worst of the uncertainty has passed exit quickly.

3. If the institutional structure allows, focus more on direct business and household support that targets the shock at hand - rather than maintaining job matches.

4. Invest in the infrastructure to provide support to households and firms so a wage subsidy is not necessary in the future.

JobKeeper and other policies

On March 30th 2020 the JobKeeper scheme was unveiled. This was 7 days after the announcement of an Australia wide lockdown and the second series of COVID policies (JobSeeker expansions and payment increases, tax adjustments).

This was a full 13 days after the New Zealand equivalent scheme had been implemented on the 17th.

I had nothing to do with the design and introduction of the New Zealand policy, other than being in the room of the people who were working around the clock to set it up.

Those that stood up this policy buried themselves into the work with an incredible desire to support their communities through a true global natural disaster - and exactly the same thing will have happened with JobKeeper in Australia.

In New Zealand policy makers had the “advantage” of the Christchurch earthquakes. This provided a roadmap for the use of wage subsidies during a natural disaster. So once the pandemic was officially announced it could be whipped out.

This also led to extremely high levels of uptake.

Another country took another approach which - at the time - was seen as madness. The US and PPP loans. The US policy interventions were less interested in retaining job matches, and instead wanted to keep households and businesses solvent through the crisis.

As a result, the PPP scheme was not introduced until 24 April, and took the form of a concessionary business loan for general expenses based on payroll. It did have retention properties with forgiveness rules based on retaining a portion of workers on payroll.

This scheme was much more untargeted and thereby deemed to be expensive and regressive in the initial evaluations (although this view is improving). Fraud has been a lasting concern, and the need to introduce such an untargeted policy due to gaps in infrastructure is itself a concern.

On one level the US shock was quite different - as they did have a genuine large outbreak of COVID. But by the policy logic in Australia and New Zealand at the time this would have increased the rationale for such a subsidy.

So we had two key design differences - New Zealand moved faster than Australia, and the US did not move at all. How did unemployment play out during the crisis? Well … those two weeks look like they had a big effect.

Lesson 1: When you use job retention schemes during a natural disaster type crisis, the benefit comes from moving quickly.

The exit

The JobKeeper scheme ended at the end of September 2020. Just to start again for six months. So it ended in March 2021. Just to get extended in NSW with the JobSaver scheme … you get the point.

Australia struggled with its wage subsidy exit strategy.

How about New Zealand? Three months. Short-term wage subsides were allowed for regional outbreaks, but these were very focused schemes - and were cut down and debated.

I was still in New Zealand at the time and I’ll be honest. I was Edmonds-Hamilton-Preston pilled and was petrified of the wage subsidy ending so quickly - I was certain this was a massive mistake.

Just like in the Conversation article I felt like wage subsidies should stay in place while the make-up of the policy settings were adjusted towards more standard supports. And my old work colleagues, who I share a lot of views with, believed that same.

Luckily I had nothing to do with anything, and those providing advice and taking advice in New Zealand recognised that there were real costs from stopping individuals from making productive job moves.

And they were right. Unemployment increased but did not surge, individuals were once again moving jobs based on the actual opportunities at hand, and support could become more focused on preventing illiquid but solvent firms from failing, and making sure households had adequate income.

NZ research found that the cost-benefit of the scheme that was in place was over 1, but dipped under 1 for the mini-schemes introduced during “resurgences”.

Furthermore, Australian research has pointed to the benefits of the scheme being concentrated in the first couple of months - and the costs increasing as the scheme went on. This holds for both the employment effects (with related estimates here and here) and for the productivity effects.

Coming back to the US, NZ, and Australia comparisons - productivity growth in the US has exceeded both countries. If the lack of a job retention scheme did threaten productive capacity, then why has this happened? (via the Productivity Commission)

This is not to go as far as saying JobKeeper may have driven persistently lower productivity (i.e. one reading of the Productivity Commission). But the “benefits” in protecting productive capacity appear to have been overstated, while the “costs” in preventing job reallocation appear to have been understated.

Lesson 2: Have a clear exit. Once the worst of the uncertainty has passed exit quickly.

Alternatives and the outcomes of JobKeeper

The restriction to job mobility captures the core benefit - and cost - of such a scheme.

To understand this we need to ask - how is a wage subsidy different from providing income support to households or concessionary loans to businesses?

I have a picture here from my colleague Lachlan Vass that explains why:

So we do a wage subsidy - instead of other policies - if we believe there is some lost match value that will be destroyed if people separate.

Note: Now, we are assuming that - in the absence of a wage subsidy - we would provide liquidity support for firms and income support for households. If we were not going to do this, the calculus would be different.

So lets think about separation.

For a wage subsidy to be the right policy, for some reason workers and firms that are really well matched together need to separate. And then these people cannot find each other again in the future.

As time has gone on, this argument has made less and less sense to me.

If the job is really valuable to an employer, then as long as they can stay afloat they won’t fire the person. If the job is very valuable and they separate for a short-time, then the employer and employee are able to contact each other - and get back together to do their beautiful work if they need to.

If you both want to work together, is it that hard to agree to get back together?

The idea that employers and employees will be randomly thrust away from each other, to never return again, just doesn’t make intuitive sense - and definitely does not match the US experience.

Furthermore, in Australia we find little evidence that the match quality of JobKeeper supported jobs was particularly high when looking at worker outcomes following JobKeeper.

Our logic for this was two fold - a description of the prior earnings/tenure of jobs and the outcomes in terms of retention and wages. If there was substantial value in that match we would expect the match to be retained going forward and a wage premium for doing so - neither of which were observed.

Secondly, we also roughly estimated the match effect in an empirical approach and looked at the distribution of these match effects among those who received JobKeeper. These effects were similar to other jobs in the economy.

The justification for a relatively limited match effect mirrored our discussion of Whyalla Steelworks and the growing literature on such effects.

However, I don’t want to overstate the strength of our evidence - COVID was a specific shock, and overreactions to uncertainty combined with congestion externalities in labour markets could themselves be a big concern. But I have not been sold on that case … yet. As has been stated, understanding the role of such schemes is an area that needs more research.

Lesson 3: If the institutional structure allows, focus more on direct business and household support that targets the shock at hand - rather than maintaining job matches.

So no JobKeeper ever?

No no. JobKeeper met its goals in a crisis. Current evidence on improvements is only partial and more work should be done. We know the system works well through the ATO. Finally, the public understands the system, and there is political and social goodwill to the scheme.

If there was a pandemic right now and Treasury kidnapped me to force me to write advice on what should be done, the JobKeeper program with some adjustments (namely a very clear set of conditions for ceasing the scheme) would be an option - and it would be one of the preferred options.

But if we can build up the infrastructure for providing support to households and businesses directly, it begins to look more attractive to do that directly.

Wage subsidy schemes are not a first best policy for the intervention we are trying to achieve during a pandemic. They are a policy of convenience due to limits in state infrastructure.

We should invest in the administrative state now - improve IT, lift the size and capability of the public sector. It served us well during this crisis as noted in a recent book about the pandemic, but it can still serve us better.

So this gives a clear lesson 4: invest in the infrastructure to provide support to households and firms so a wage subsidy is not necessary in the future.

It was a free-form chat where we just went in to talk tax reform, and saw where we went.

I had a lot of fun chatting with an international public finance expert about tax policy - and was surprised at how few hot takes were had. Of course, this could be because I’ve spent a bit of time with tax economists in the past - so maybe the takes will sound a bit spicier to a general audience!

Structure

The podcast is close to 100 mins long, so I thought I’d list down some topics below in case you want to jump to certain parts. In order the topics covered are:

• Are we ready for tax reform now in Australia?

• Negative gearing (you can read what the “right view” mention is here).

• Comparing “ideal” systems in New Zealand and Australia.

• Standard deductions.

• At about 20 mins we kick into frameworks and principles:

  • Efficiency-equity trade-off (if you need a reader on this - I can recommend this post).

  • A flawed focus on “amount of revenue” rather than distortions is problematic for good policy (but stems from political economy concerns about political tax expenditures).

  • Do we sufficiently account for behavioural responses when looking at tax changes in Australasia (i.e. dynamic scoring).

  • Accidentally had the relevant books sitting on my desk!

• From about 32 mins in, we discuss systems thinking in tax, and the “one-instrument one-tool” rule to avoid everything bagel reforms. The key example discussed is our good from GST.

  • One thing we didn’t note is that GST is much less regressive over a lifecycle than it is at a point in time - just didn’t have a chance to drop that in ;)

• At about 40 mins we get into the communication of tax frameworks publicly - exploring the role of private sector and public service institutions to communicate these ideas.

  • How much is a lack of communication coming from the difficulty communicating these ideas, versus the lack of time to invest in building coherent frameworks?

  • Between around 50-60 minutes we find agreement on our view about the public sector - but I bet you won’t guess what we agree on! Well maybe you will. [Note: When I mention the US person it was supposed to be “they had to fly over the night before economy class while working on the flight over” - the business class was me mispeaking like normal]

• An hour in we discuss that labour supply isn’t everything for thinking about behavioural responses to tax.

  • Includes a spicy take about economists talking about tax.

• Five minutes later, we finally define comprehensive income, talk about types of tax, and finally talk about capital gains taxes. Is the capital gains tax discount actually good policy?

• At 1:17 we discuss corporate taxation in Australia - is it about withholding or the taxation of rents? And how do the international tax reforms fit in?

• At 1:25 - summing up, and then including some points on transfer payments. Focusing on concerns about targeting and coherence.

  • There was a fairly large discussion I cut out here as we were both discussing substantial details of unreleased work without adding too much to the framework discussion - and it would be more fun to save that until the work is finished and then have a full chat on transfer systems.

In order to facilitate the debate I ended up talking as a New Zealander - showing how much I’ve forgotten after three years such as the name of the bright-line rules for capital gains on housing.

Readings used in the post

The Blueprint reports that Steven talked to were:

• Standard deduction,

• Unemployment Insurance.

The inbound investment framework from New Zealand that was discussed can be found here. The Auerbach (1991) piece on inflating gains by some risk-free/discount rate is here. While the Aguiar, Moll, Scheur paper on capital gains that I butchered can be found here. And here is our mate Kaldor.

Also the Destination Based Cash Flow tax newsletter noted. While the framework for the “digitalisation of tax” process we discuss is here.

On unemployment insurance, this is the paper Steven pointed to is summarised here, with a fairly recent piece also here. And for labour supply and transfers + abatement maybe these links will help (abatement post, participation margin post) .

Also felt like it is good to add the relative tax-GDP ratios given dicussion about them.

A couple of weeks ago we reminisced about the lead up to COVID and the declaration of the global pandemic. Within a week of this announcement both Australia and New Zealand were in lockdown - something that was mentally inconceivable merely a month earlier.

Blog recollections can only take us so far. There were four posts between the 13th and 27th of March on TVHE - which I will discuss below - but there was a lot that Andrew, Gulnara, and I could not write about given the live policy issues.

During this I’ll highlight different directions Australia and New Zealand took over the first couple of weeks of lockdown. Given this who knows, we might have a post about JobKeeper to celebrate the five year anniversary of the scheme ;)

Blog and OECD policy documents - the real memory lane

March 16th - three days after the global pandemic was declared, but a week prior to lockdowns. This was when the crisis really started to show up in public.

This was the day that the Canberra National Folk Festival was cancelled.

[Looks like the cancellation was a bit too late for the group on the far left whose arms have merged together!]

Well, that and a State of Emergency in Victoria.

In this environment, two important economic institutions stood up to share thoughts on policy responses - the OECD and Gulnara.

Starting with Gulnara’s post, things were moving so quickly that four separate blog posts needed to be written at once in one blog (TVHE version with the Tweets showing)!

At the time economists were doing their usual thing - trying to test out different frameworks and ideas to say contrarian things. Is this actually a positive demand shock and hence is monetary easing wrong? So we wanted to note why this doesn’t appear to be the case.

The rest of the post was focused on concepts that are very familar now - “insurance”, “protecting productive capacity”, and “this is a health shock not an economic shock”. The first has aged much better than the rest - and unsurprisingly it was Greg Mankiw making the most sense.

The insurance shock is fairly straightforward - this was a tail risk event occuring to a specific group of people at a specific time. Governments can shift this onto their balance sheet and redistribute the burden of COVID across people through time to make it fairer. Little did we know a key mechanism for this future payment - large scale inflation - would completely break large parts of society even more than being locked down (something the comments to a 2022 article of mine make quite clear).

Protecting productive capacity was where the rationale for job retention and business loan schemes that appeared - I think the logic is best described by the Australian economists that pushed for it.

These businesses would be viable if it weren’t for the necessary public health measures currently being taken. Allowing them to fail would mean the pointless destruction of valuable resources.

In the absence of JobKeeper - or the wage subsidy in New Zealand - there was a concern that solvent but illiquid firms would fail, and/or that productive matches would be severed. So these policies were needed to allow the economy to “unfreeze” with more capacity than they would otherwise.

Maybe not perfect - but a huge amount better than nothing. So this framework was - in the early months of COVID - a good one.

The health shock point was a line to promote the discussion of public health above a blind obsession with preventing a recession. There is now a health externality, we need to have individuals internalise it, and that will generate an optimal recession.

This framing was true - but this is still economics. The willingness to abdicate at this point made it harder for economists to push for cost-benefit analysis later - and I’d argue is part of the reason why economists are so quiet post-COVID about everything … at least relative to pre-2020.

What about the OECD?

I was in a tax department during COVID, and so the most active international agency I saw was the OECD. They were reaching out to tax authorities to communicate about policy and economic frameworks, and to ask jurisdictions to list the different policies they were introducing and why.

The meetings were hardly at pleasant times for New Zealand - but the documents that came out were useful.

You can see the list of documents - and their regularity - here. The first full advice documents were the two one-pagers released on the 16th - one on cash flow support for households and businesses, and one on business continuity for tax authorities.

Business continuity was a significant concern - with a pandemic underway how can the tax agency interact with taxpayers, not just to raise revenue but also to provide support.

A key lesson during this early stage was that most governments were better at raising revenue than at handing it out. For this reason, tax agencies were better at continuing to interact with customers than other agencies - and so an increasing amount of government support would end up being delivered by tax agents.

But before that the purpose of tax changes were to keep households and firms liquid when they are solvent - so managing cash flow. Allowing deferrals on GST and payroll tax been done in Europe already, and were being recommended in other countries now. This included removing fines for late payments, and being more generous with regards to tax withholding based on prior revenue (given the economy was on ice).

It wasn’t until the 20th that the OECD started suggesting increased generosity in terms of social support in order to “protect productive capacity”, alongside more detailed discussion of the role of expanding benefit eligibility and lessons across countries.

By the 24th the OECD was back to normal - switching from single page flyers back to full papers. The focus this time was a justification for lockdowns and “flattening the curve”.

Although these documents largely did confirm what was already being done in places like Australia and New Zealand, they did help clarify trade-offs, empower the global public service to move forward with these policies, and helps states with more limited state capacity deal with COVID. It is crazy to see how much ground the OECD covered in just one week.

Path to lockdowns

On the 17th of March New Zealand was inspired by the arguments above and internal knowledge about disaster management - and introduced a Wage Subsidy. This was introduced well prior to lockdowns, a fairly important distinction. However, New Zealand also did not lift core unemployment benefits (although work hour requirements were removed from the in work tax credit, and at a much later date a form of income insurance “CIRP” was introduced).

Australia did do earlier lump sum payments to benefit recipients, but the big COVID supplement was not announced until the 22nd of March (with payments only starting from the 27th of April). This was an increase in unemployment benefits. However, at this stage there was no wage subsidy.

There was a series of business supports coming online - alongside tax deferrals - during this period. OECD guidance was influential at share ideas across jurisdictions.

However, while tax deferrals (and immediate expensing) were well regarded - the loan structure of a lot of business support was driving low take-up in both countries. As a result, there was a lot of focus on the ability for the central bank to provide sufficient liquidity and a shared view that part of the purpose of “wage subsides” was to provide cash flow support to businesses that are otherwise solvent.

This explains Gulnara’s relatively niche sounding piece on money financing and unconventional monetary policy on March 19th.

New Zealand’s lockdown started as partial on March 21st, full on March 23rd, and by March 25th became one of the most restrictive lockdowns in the world. Australia entered lockdown on the 23rd. When the proper lockdown started in New Zealand Andrew Coleman also shared his experience of lockdown in Morocco with us.

By the 26th Gulnara and I found ourselves busily trying to do our jobs but unable to shop - so we decided it was time for more talking about Twitter alongside demand and supply shock (TVHE post with embedded tweets).

At this stage Australia still doesn’t have a wage subsidy. In New Zealand we don’t realise just how much this policy has prevented surging uncertainty and job loss - we’re instead focused on the frustration of not being able to order take-out during a lockdown.

But as the tweets show, there are incredible economists arguing about how we should be focused on the policy response for this - whether it is about fiscal responses or funding cures.

Where are we by the 27th?

In Australia the country is in lockdown, but JobKeeper is not in place. Unemployment is surging as will be confirmed in the coming month.

In New Zealand the country is in lockdown. There are wage subsides and we’re all being informed to be kind. My two jobs appear to be writing short policy briefs on a million different possible tax adjustments, and teaching intro economics from the dinning table to 1,000 students - both things keeping me busy and sane thankfully.

And I didn’t even mention that a week earlier both countries had shut their borders!

A month before this happened, the very idea we would lock down like this appeared impossible. A month in the future it, and the concept of working from home, would be almost natural. Crazy times.

In this podcast, you can share this journey with me. We spend 10 minutes on Budget structure and history, 15 mins discussing productivity policy, 20 minutes on NDIS, and then have an extra 30 min section where we talk about what we would do if we were kidnapped and thrown into the Treasurer hotseat with no preparation.

Needless to say, if there is a plan to kidnap anyone I think this conversation makes it clearer you should grab Lachlan instead of me.

Although by the end I think we were both getting pretty spicy!

What I think we mentioned - but perhaps couldn’t emphasise enough - is the sheer fiscal pressurs the government is facing. If you want to understand this give last week’s AFR piece by Chris Richardson a careful read.

There are long-lasting structural deficits and elevated revenue risks making this a situation where we really need to think about how we achieve consolidation at the lowest cost. This is why we were so focused on both productivity (to increase the revenue base) and the NDIS (an unexpectedly large major area of expenditure).

Keen for your thoughts on big topics for the day - comment down below and all that jazz.

I’m sure we’re all sick to death of talking about tariffs. It has reached the point where people are saying we should stop talking about the economics of it and recognise it is a cultural war issue.

Well I am going to talk about the economics of it, and try to give some advice of what we should do in this situation.

As a side note a lot of people told me that Australian article was not good and would make me angry as an economist - but I actually found it quite reasonable. He wasn’t saying that the economic consequences don’t matter, but instead that the choice was being made on the basis of a vengeful intention of a certain group independent from broad economic consequenes.

The situation in the US is insane and this appeared to just point that out.

Anyway, to my post!

tl;dr Don’t do “tariffs” back as they will largely fall on domestic consumers. Instead the US actions legitimise the introduction of a digital services tax in both Australia and New Zealand - with a related tax credit for domestically based firms. This incidence of this tax will only fall on US digital companies - the same companies that are willing to sell out democracy for a few dollars in any case.

Side note: Even given this argument I have big concerns about a DST or any transaction tax - but if the choice is that or tariff retaliation I would lean towards a DST.

I’ve heard enough from economists

Yes yes, but since you are here now lets have a chat. The US has imposed tariffs on Australian steel and aluminium. Beef and wine will come. As will further attacks on the domestic treatment of IP and medicine.

Nothing will stop these as Turnbull has pointed out. The US government and likely most of the public have convinced themselves they are the victim - even though they have the highest incomes in the world, receive favourable loan terms, and have received pretty ridiculously long IP terms from the rest of the world.

Trading with a society that is plagued with such a strong victim mentality that it appears the country is under a form of mass hysteria will create risks, and no actions taken in Australia will change what they will do.

But applying counter tariffs are fundamentally not in Australia’s interest.

This is not because some group of braindead individuals in the US will retaliate in someway - but because the incidence of the tariff will fall on Australian consumers.

Lets return to our advanced modelling software to describe this, Microsoft Paint. Take a situation where we are importing a product, and then lets introduce a tariff - what does it look like?

Beautiful. The red line is the domestic demand curve, the blue line is the domestic supply curve. Where they cross is the price without trade - which is a lot higher than the prices we are looking at.

The grey line is the world price without tariffs. The green line is the world price with a tariff. The idea here is that, if we introduce a tariff we are a small open economy - so US exporters will just go huh and sell elsewhere if a tax is applied. As a result, the price rises by the full tariff.

In other words, the US producer will sell in a market until the prices between markets equalise - if we introduce a tariff the pre-tax price will need to rise until the post-tax price the exporter receives is the same as it would have been without the tariff.

This higher price leads to domestic producers making a bit more (the shift from A to B), and domestic consumers purchasing a bit less (from D to C). But the full burden of the tax is on our dear consumers who keep buying.

Hence, introducing a tariff is just cutting off our own nose to spite our face - it is not something we should consider.

So we just do nothing

The United States has made a decision to blow up the rule based order. I have no interest in “blaming Trump” - there are enough individuals in the US both voting for him and and supporting his actions. Supported by a media that has accepted letting democracy die in darkness.

One person doesn’t have power, it is the US public who is responsible for this. If Australia and New Zealand were to go the same way, Australian’s and New Zealander’s would also be pathetic losers who see themselves as perennial victims, and are scared on their own shadow when they walk outside. As most of the US is right now.

In this context, the standard rules that Australia and New Zealand have held to in order to foster cooperation are simply not necessary, and we are well within our rights to apply legal and tax rules that we believe maximise the welfare of Australians.

Now there is something where the legislation has likely already largely been drafted in Australia and New Zealand and where other countries have already applied such a policy. A Digital Services Tax (DST).

Why a DST and not a tariff?

The incidence of a DST does not fall on consumers in a country - it falls on the margin of the digital service provider.

How? This is a tax on the revenue generated by a digital service in a country. So the price should go up like with a tariff right? No.

In our example above, the US producer had a good and they wanted to sell it - after the tariff is introduced they will simply sell it somewhere else unless the Australian consumer pays the tariff.

But with digital services we would apply this to consumption that is non-rival - if I use facebook it does not mean less facebook can be sold to others, if I watch a movie on Netflix it does not stop Netflix being available for another purchaser. As a result, taxing the revenue of a digital service does not lead to the service being sold in another market - as long as the revenue earned is positive the digital provider will stil sell it.

This difference means that a DST simply reduces the margin earned by digital service providers and does not change the quantity sold - so all that happens is Australia makes some tax revenue.

Note: There is a limit as the provider will need to meet its fixed cost to be in the market, so if the tax rate was too high the provider may simply exit - outside of full provider exit the incidence falls entirely on the company.

Now a big concern about proposals across Australiasia is the double taxation of domestic firms who provide digital services within the country (ANU TTPI) - although this did not stop the Digital Services Tax bill in NZ in 2023.

But what do you know - the US has now overruled the WTO on everything to introduce tariffs! As the key reason why a DST had to be applied on both domestic firms as well as international was the WTO, it is actually quite simple to just exclude domestically headquartered firms - rather than using some weird de-minimus to do it by stealth.

But surely the services will pass it on due to market power?

Market power means that service providers are already maximising their profit in a jurisdiction at current prices. While the near zero marginal costs implies that prices and revenue are equivalent. As a result, even with a tax the “profit maximising” price is the same price!

Market power generates the rent that is being taxed by the DST - implying the tax on that rent is earned where it is extracted, rather than in the US.

Now these providers will lie to us that we are paying the tax. They will increase the price immediately. They will itemise it on bills. They will buy ads and pay unprincipled economists to tell everyone this is the case - because it is in their interest to not have their profits taken away. This is not a conjecture, I have had providers directly admit this to me - stories I will not go into any further to protect confidence.

And in a horizontal equity sense it is a bit “unfair”. These firms are getting double-taxed.

In a rules based order such tax instruments would not be used. Concerns that digitalisation is eroding tax bases in destination countries would be considered through other means.

Current uncertainty will pass, we should ride it out

I have sympathy for this. But unless a number of individuals in the US take responsibility and stand against authoritarianism then we are not returning to the old order.

And it is largely US digital companies who have done everything in their power to help this order break down.

My apologises if you find this post overly negative about these companies and the US. However, I would not take back a single word I’ve written above.

Through the 1990s and even during the last US administration, people in the US were willing to bemoan the lack of voice for specific groups - and demand that we take the power back. But as the US walks into authoritarianism - without the excuse of a recession or an especially difficult last few years for most - the same groups are either silent or supportive. In a generation’s time the shame their children will have for their actions is incalculable.

In Australia we do not face this. But we also no longer need to keep making choices that benefit the US in order to support the rule based order that does not exist. So lets consider putting a DST in place.

However, I’m writing a post below to go alongside our pod - as I think our discussion raised some fun points that are good to listen to, but I just wanted to add a bit more.

What I do want to discuss today is a theme I have in mind that links together the economic consequences of AI, an essay from Keynes, and why a strong safety net is a central part of how we manage our path to prosperity.

I think this type of discussion is especially important as we see the US rip up its own social contract in a way that I don’t believe anyone truly sees as just - but many may not have thought it through.

To prevent that happening here we should be explicit in talking about it.

Strap in, between the pod and a long post there is a lot here - hence why we’ve put it up on a Sunday so you can enjoy it over coffee and whatever substitute for eggs you’ve been able to find.

tl;dr Technological change will boost the opportunities of our children and grandchildren, but we need to be mindful of how we support those who might lose out now. We have benefited from the costly transitions taken on by the generations before us, and have the same responsibility to those who struggle now and those who would benefit in the future.

You are just making more ChatGPT images aren’t you

Of course! I’m a big fan of AI tools - or what I currently view as an advanced and expanded form of Google Search.

So how is AI functioning in a labour market sense? If I want to achieve a task - say write a blog post - there are a set of smaller tasks I need to achieve.

1. Come up with an interesting question and novel insights that an audience of passionate and thoughtful Australasians would want to consume.

2. Structure the narrative.

3. Write it in a readable way.

4. Put in some images (graphs and pictures) that help the flow and narrative.

At present I only use AI for pictures - so my failure to achieve the other tasks is purely on my own shoulders.

As a result, I come up with ideas and narratives, pull data and graph it, and write up the post myself - and then with a few small prompts I add some colourful pictures. This saves me a lot of time, and hence is a complement to my production of blog posts, by increasing the quantity and quality of posts my labour can produce in a given time … if I was paid on this basis this would increase my wages.

But there might come a day when I could train an LLM on both my historic blog posts and the news, and ask it to write posts in my style on these topics. In this way you could remove my labour from the blog process entirely, and just engage with LLM Matt - this would substitute me out of the blog process. If I was paid to produce this my wage would be determined by the cost of this substitute - which would likely reduce my wages or make me unemployed.

The complementarity and substitutability of our labour from this capital is important for understanding the role of AI. The concern of Daron Acemoglu is that this will be relatively substitutable, and thereby lead to unemployment, labour market disruption, and lower wages.

Ohhh no - time to destroy the machines

We’ve heard these stories before. If you want a long history I have a series of posts from a decade back on factor shares that you can have a little look at (Intro, Classical, Marxian, Neo-Classical, Marshallian, Post-Keynesian, Neo-Ricardian, GE/Modern) - as I feel this captures the way a lot of these debates moved through time.

And I’m sure you’ve heard plenty of examples from the industrial revolution. But I want to do something different - I want to go to a period that is a lot more relatable for today, the Great Depression and the rise of modern authoritarianism.

And to do that I need to introduce an essay we chat about in the audio about - The Economic Possibilities for our Grandchildren by Keynes. This is also pertinent because we are the grandchildren that were the theme of this essay and its accurate predictions.

The context here is that, in 1930, the preveiling view was that the unemployment being experienced was “technological” - although exacerabated by fiscal and monetary policy that was too tight. This was the end of a historically unprecidented improvement in capital accumulation and technological know-how - and Keynes was relying on the lessons of the earlier Long Depression to understanding this.

For I predict that both of the two opposed errors of pessimism which now make so much noise in the world will be proved wrong in our own time; the pessimism of the revolutionaries who think that things are so bad that nothing can save us but violent change, and the pessimism of the reactionaries who consider the balance of our economic and social life so precarious that we must risk no experiments.

This initial quote from the piece highlights that the public response to such change and uncertainty is a mix of fear and violent revolution. The experience of COVID and the life changing disruptions since have had the same effect on our mental state - and his warning to think carefully about technical change and how we deal with shocks is important.

This means unemployment due to our discovery of means of economising the use of labour outrunning the pace at which we can find new uses for labour. But this is only a temporary phase of maladjustment. All this means in the long run that mankind is solving its economic problem. I would predict that the standard of life in progressive countries one hundred years hence will be between four and eight times as high as it is. There would be nothing surprising in this even in the light of our present knowledge. It would not be foolish to contemplate the possibility of afar greater progress still.

But for our thoughts on AI this quote gives the key point - technological progress will increase the material living standards of people in society, but we require political agreeement to go through that transition.

Under given structures and sets of skills, large technological change can generate a period where prior capital (both physical and embedded in our human knowledge and skills) is stranded. However, once we are able to retrain and adjust to provide our work time to the areas where we are relatively more effective than the machines, as a society we will be wealthier and better off.

And the prediction of a 4-8x increase in material abundance was right - GDP per capita has increase 5+ times over in the past 100 years.

But this requires the transition happens. To take things a step further, making sure society does not swing to extremism during the transition may require that we identify and support those who struggle with it - and that we communicate these risks in a way that is trusted (Keynes comment that economists will hopefully be seen as boring and trustworthy as dentists - to any dentists this is a complement).

But this time is different

There is a clear matter to keep in mind here. If we are saying there is no comparative advantage left for humans we are equivalently saying there is no scarcity.

If there is no scarcity then lets be blunt - why are we allowing poverty and want at all? Why as a community do we allow poverty and want? To quote Keynes again:

All kinds of social customs and economic practices, affecting the distribution of wealth and of economic rewards and penalties, which we now maintain at all costs, however distasteful and unjust they may be in themselves, because they are tremendously useful in promoting the accumulation of capital, we shall then be free, at last, to discard.

So now say that we do have scarcity, but the structure of labour and capital markets is such that the return of activity becomes very concentrated - and those that have not can neither earn labour market returns or accumulate capital in a why to benefit from this. The solution is not to gut the welfare state as the US is, but to strengthen and extend it to share the benefits of technological change.

Even with scarcity it is important to reflect on where value comes from when considering technological progress. If you were born 200 years ago you would not earn nearly as much as you do now, if you were born 50 years ago you wouldn’t either - irrespective of the lies propogated by authoritarians and contrarians to make you feel like a victim.

The growth in incomes since the industrial revolution means that you receive more solely due to the luck of how and where you are born. You were given the opportunity to earn more, and your efforts rewarded you with more, but this does not imply it was just you that created this.

As a group we have learned to organise better. We have learned more about how the world works. Prior generations have constructed buildings and other forms of capital - which we use to produce things to consume ourselves.

We have an obligation to both pay this forward (build for our grandchildren) and support those who had bad luck (those who experience poverty).

If you are in a median income family on low six figures then life can feel hard - it is difficult to keep up with the Joneses, hard to meet the expectations of those around you, and difficult to deal with the shocks that life gives you. But the shocks we face are less than those before us, or those who truly struggle with low incomes now.

Making ourselves the victim and not seeing that we are truly fortunate - and have a responsibility to share that fortune with those that have less - is the reason why the media is filled with hate, and democratic institutions are rotting before our eyes. None of us should feel individually responsible for the whole world, but we should feel obligated to have empathy for others and take on actions consistent with that.

Like Keynes did in 1930, we should be asking ourselves how we can build a world where our grandkids will have more and where we have done our best to support our brothers and sisters when they are facing their hardest trials. Not demanding that this world does more for us.