Wednesday, September 17, 2014

Capital Gains Tax Bleg

When I first started writing posts on capital gains taxes three years ago, starting with this post and this one, they were sort of a bleg. I have never understood the rationale for CGT, as the arguments that are usually put seem to involve shifting definitions, or incomplete partial-equilibrium analysis. So I wrote those two posts to explain why I thought the arguments in favour don't add up, hoping that someone could counter with a coherent argument. With a CGT defended within the context of a coherent model, it should be possible to phrase the debate in terms of differences in either values or empirical beliefs about the economy. Three years on, I have seen a lot of public discussion of capital gains taxes, but still don't understand what is the model from which proponents draw their conclusions.

But now I have a different bleg. I would like to know how actual CGTs that have been implemented elsewhere (or the ones proposed by opposition parties in New Zealand) would deal with a particular issue. This issue is easiest explained with a series of examples:

  1. Imagine that you are a householder with a portfolio of $2,000 of shares in a single company that is earning a 5% rate of return on its capital. At the start of a new year, you decide that you want to save some more, so you buy $100 in a different company using money you have earned in the previous year but not spent. You now have a portfolio of $2,100. This increase in the value of your portfolio would not be classified as a capital gain. It simply represents increased savings.
  2. Now imagine that instead of putting the $100 into a different company, you bought $100 of freshly issued shares in the same company that you already have a shareholding of $2,000.  That still doesn't count as a capital gain, right? The company uses the money from its new share issue to buy some capital equipment, which will also earn a 5% rate of return, but what they do with the money is irrelevant.
  3. Now, imagine that in the previous year, you were paid a dividend of $100 by the company in which you own $2,000 of shares, and you bought $100 of freshly issued shared by the same company. Again, this makes no difference. The fact that your purchase of new shares was in exactly the same amount as your dividend payment, is irrelevant; the additional $100 was paid for out of your total income and was available for buying shares because of a choice not to use it on consumption. 
  4. Now make one more change. Instead of paying out $100 in dividends and then issuing $100 of new shares, the company simply retains the profit, pays a dividend of $0, and uses the money to pay for the new capital, as above. The company has increased its ownership of capital equipment by 5%, and so the value of the existing shares will increase by 5%. So now our shareholder sees that his shareholding portfolio has increased from $2,000 to $2,100, just as in all the previous cases, except in this case he hasn't bought any new shares; he has seen what looks like a capital gain of 5%. Except, it is not really a capital gain; the reinvestment of profits by the company instead of paying out a dividend is a form of saving that is imposed on its shareholders.  

In the absence of taxes, the only difference between example 3 and 4 is in the default position. In 3, the shareholder receives the dividend and needs to make a decision to buy new shares to turn that dividend into saving. In 4, the default is that the dividend is saved, and the shareholder would need to sell $100 of shares to convert that saving into consumption.

But what if we add capital gains taxation. Wouldn't a CGT induce a difference between example 3 and example 4, adding additional taxation in the latter but not the former. And wouldn't this induce a distortion in which the tax system created an incentive for firms to pay out all their profits as dividends and then raise new capital rather than retaining profits for investment? What I would like to know is how to other countries deal with this distortion in their CGTs (if at all), and how would the opposition parties in New Zealand plan to deal with it.

It is also interesting to note that currently in New Zealand, there is a slight tax distortion that favours retained income over dividend payout (as the corporate income tax rate is lower than the top rate of income tax). At the time the rate was lowered from .33 to .30 in 2008, the then Labour government said this was a deliberate distortion as a kind of nudge to encourage retained earnings and hence make saving the default. Does Labour now think that we should be changing the nudge to consumption by moving the tax advantage the other way?

Oh Christchurch, revisited

My chapter on the failures in the Christchurch rebuild is up at Public Address.

I'll be speaking on it at a lunchtime panel tomorrow in Wellington. Perhaps I'll see you there.

From my chapter:
If we learn anything from the intersection of the work of Jane Jacobs and of Ed Glaeser, it’s that cities are organic. The best parts of cities emerge from the distributed decisions of thousands of property owners, building near each other to take advantage of complementarities in location that they could foresee and that the planners couldn’t envision. SimCity takes no account of the wishes and dreams of the Sims. All of the small actions of distributed individuals can add up to something wonderful, if only Council and the bureaucrats would get out of the way and let it happen. Instead, we had the worst of all possible worlds: the insistence that a perfect central plan supercede these decentralised decisions, but absolutely no bureaucratic capacity to set or follow through with a plan.

Monday, September 15, 2014

Parker versus NZIER on Capital Gains Taxes

Labour finance spokesperson, David Parker, sent this letter to the New Zealand Institute of Economic Research, regarding a report they wrote for Federated Farmers on Labour's proposed captial gains tax policy. 

I don't have time to read the original report or the earlier one by BERL referred to in the letter. What struck me, however, is that the points of disagreement are really quite tangential to the issues that should be at the heart of a debate on the merits of a capital gains tax (CGT). Let's take these in turn.
  1. Parker believes the tax will raise more revenue than NZIER do. A CGT that is designed to ensure savings is directed to the most productive investments rather than be motivated by differential tax treatments is one that would raise zero revenue. Any CGT that increases revenue is one that increases the existing tax distortion penalising saving relative to consumption. Of course, one might have the objective of increasing the tax on saving for the equity objective of increasing the tax paid by the rich, but that is a different objective. Either claim the tax will raise revenue, or claim it is about encouraging productive investment, not both.
  2. Parker believes the proposed CGT will be more progressive than NZIER do. This may be true, but if the objective is to increase the progressivity of the tax system, the policy question is whether it would be better to achieve this through increasing the income tax rates that would target high levels of wage and salary income as well, rather than just one component of capital income. 
  3. Parker believes the current income-tax paid on trading is not important enough to make the claim that we currently have a CGT. That is possibly true, but it misses the point: We do have a perfect, all-of-the-advantages, none-of-the-disadvantages 13% CGT. It is called GST
  4. Parker believes that a CGT will have more impact on housing speculation than NZIER. Again, this is possibly true, but why is that a good thing? Let's reiterate some points made previously, here and here
    • Housing speculation is only profitable if house prices are expected to rise in the future. That is, speculation can't permanently increase house prices; it can only bring the increases forward in time. A policy designed to make speculation less profitable is a policy that admits that nothing will be done to curb the underlying drivers of house-price inflation. 
    • To the extent that bringing forward future house price increases creates an incentive to build more houses, speculation will actually lower future prices. One can claim that the tax distortion that means home owners pay no income tax on the imputed rental they earn from themselves leads to a country having too large a housing stock, but not if your rhetoric is about making home ownership more affordable. 
    • And curbing speculation in home ownership, to the extent that it has an impact on home affordability must operate through making renting more expensive. Again, this might be an objective, but not one that is easily squared with rhetoric concerned with poverty levels. 
One final point. Parker claims that the Australian experience is illustrative, because they had a CGT excluding the family home, their "home ownership rate was lower than New Zealand's. Now it is higher and ours is at a 60-year low". Is the claim that Australia's CGT had an impact on New Zealand's home-ownership rate? Or is this a difference-in-difference estimation that assumes as a control that Australia's rate would have fallen like New Zealand's but for the CGT? 

One of these is a lie

From February:
The GCSB and the SIS were asked whether they get funding directly or indirectly from the governments of Australia, Canada, the United Kingdom or the United States.

Both withheld the information. They also refused to say whether any foreign government paid for any positions within the agencies.

However, they did confirm that they do not collect wholesale metadata on New Zealanders and, to the best of their knowledge, American counterpart the National Security Agency does not either.
Today:
Vodafone is setting up cable and internet at our new house this morning. I should then be able to watch tonight's relevant programming.

If GCSB and the SIS were just playing semantics over the term "wholesale", I call that a lie.

I wrote in February:
The GCSB has to know that there's a strong chance that, if they have been collecting metadata or if the Americans have been collecting it here, it'll be revealed in the forthcoming Snowden releases. They'd also know that, if they lied to Parliament, it would be very bad, and that if the Americans were doing it here without GSCB's knowing about it, GCSB would be seen to be incompetent or wilfully ignorant. I further expect that Kiwis wouldn't have much truck with semantic tricks on verb tenses or definitions of "wholesale". And so I must expect that they know that it isn't being done here and hasn't been done here. This makes me happy.
I hope to stay happy.

Update: here's the RadioNZ interview with Greenwald.

Friday, September 12, 2014

Strategic voting on the right

So the latest chatter on the NZ right is that strategic voting for the Conservatives is a great idea. I'm going to disagree.

Under New Zealand's MMP system, a party enters Parliament on earning one electorate seat, or 5% of the Party Vote. In the former case, the MP enters Parliament with however many additional MPs the Party would be entitled to if there were no threshold in the Party vote: 2% of the vote gets 2% of the seats, if you have an electorate. If you don't have an electorate seat, and you get 4% of the vote, those votes are wasted: the composition of Parliament is determined by the Party Votes of those voters supporting parties that enter Parliament.

And so what do you do if you're on the right, if you want a National-led government, and if you're worried that National will lose if the 4% (or thereabouts) gained by the Conservatives is wasted? You could be tempted to vote Conservative to help push them over the line so they go into coalition with National. National then isn't forced to look to Winston Peters and New Zealand First for support.

I think this reflects short-term thinking. Winston Peters is near retirement. After he has retired, it seems pretty unlikely that New Zealand First will continue. The Peters personality cult will end. And, for a single retirement term, Peters' price may more likely be in approbation than in real policy.

If the Conservatives enter Parliament this term on a strategic vote, we might expect them to be around for a couple decades. They're socially conservative and, thus far, fiscally incoherent. Maybe they'll increase alcohol excise four times over, maybe they won't. They propose tax cuts but no spending cuts; Christine Rankin said they'd square the circle by turning a billion in alcohol excise revenue into four billion.

I wonder whether alcohol taxes could really go up by enough to make that happen: we start getting into tax territory where I'd be real nervous about applying current point estimates of the price elasticity of alcohol demand. The usual point estimate is -0.44: a 100% increase in the price of alcohol would result in a 44% decrease in consumption. A 133% increase in excise means about a 40% increase in the cost of low-priced beer and a 103% increase in the price of low-cost spirits in New Zealand. A 133% excise hike reduces consumption of low-priced beer by about 17%, so you get a 110% increase in revenue for the 133% increase in tax on beer, assuming no substitution over to home brewing and distillation. I'd expect things get more price elastic as you keep hiking things further (the income effect has to start biting sometime). I doubt you're into backward-bending territory with a 400% revenue increase, but taxes are going to do far more than quadruple to get quadruple the revenue. I really don't like where that's heading.

It's that kind of populist socially-conservative nanny-state knee-jerk economic incoherence that I expect a lot more of if the Conservatives get embedded into the system. Hey, let's propose a fiscally incoherent platform and then wave a referendum wand to find out how to plug the hole!

Is getting a third National term without NZ First really worth getting the Conservatives into Parliament? I suppose it depends on your discount rate. I don't like the long game on this one. I'm sure National could work with the Conservatives and make something decent out of it, but it doesn't seem a particularly good strategic vote for social moderates or liberals on the economic right who care about policy rather than just about keeping John Key in office.

Maybe Paris is worth a mass, but is Key really worth a Craig? I'd really really really prefer that National go into coalition with either NZ First or the Greens, or even a grand coalition with Labour.

Conflicts disclosure: I'm modestly short on the Conservatives' crossing the 5% threshold at iPredict, but long on National winning.

Update: Conservative leader Colin Craig has clarified the party's position: they want to hike alcohol taxes, but not to $4 billion. He also notes that our excise system "is nowhere near consistent with Australia's." He should note that the Australian system is nuts. The anti-alcohol campaigners rightly point out that the WET is distortionary and messes up relative alcohol prices. He also notes that alcohol is cheaper than water. When the kitchen faucet at my house starts supplying Emerson's at no charge, we can have a talk about that.

LEAPs forward

Foreign Policy gives us a somewhat implausible critique of Honduras's LEAP zones, the ZEDEs.

First, a bit of history. Paul Romer shifted from academic work on high-tech growth-theory macroeconomics to pursue institutional innovation. He realised, correctly, that you can't do much to change a country. But you can, perhaps, make some progress in a small region. Set up a small autonomous zone in a developing country with access to sound law, sound money, property rights and decent infrastructure, and you'll kickstart development not just for that special economic zone but also for the rest of the country through remittances at first, then through institutional leakage as the host country starts adopting the best parts of what makes the zone work.

I've been a fan of these for a while. A few years ago, a final exam question in my undergraduate Public Choice class asked students to imagine themselves a billionaire who wanted to make the world a better place: should the billionaire's bequest go to Seasteads, or to Charter Cities?

Honduras changed its constitution to allow a few of these to emerge. The Zones for Economic Development and Employment, the ZEDEs, can now be created. They differ from charter cities in that they're broader regions in which cities could be established, but they don't have to be cities.

Mark Klugmann spoke about these at Mont Pelerin this year; here's a Reason write-up from early August.

Now, over to Foreign Policy. The author there provides two critiques:

  1. The ZEDE board is stacked with Cato-type free-marketers;
  2. The zones, when established, will expropriate the current inhabitants who don't always have well-documented rights to their property.
I believe the first one to be true. It's because I believe the first one to be true that I put rather less weight on the second one. If there's anybody who fights against government expropriation and eminent domain abuses, it's Cato-type free-marketers. A bunch of Cato-type free-marketers are not likely suspects in a "expropriate peasant farmers to benefit big corporates" scheme.

The article's worth reading for a bit of background. And Paul Romer tweets that he's also a bit worried. I'm not worried about any zones that might be established by Klugmann's group. If others use the provisions for setting up other zones, that could be different. 

My print piece in today's National Business Review hits on the ZEDEs. I wonder whether we could establish special economic zones here as experiments. Imagine getting rid of the RMA in a few areas and there reverting to tort and nuisance. 

Perhaps shifting to reforms in special economic zones is an abandoning of the prospect of large-scale reform in New Zealand. But perhaps it is also the best we can achieve under the current electoral system. It could also be a reasonable approximation of best-practice: try something new in a few places, see if it works, then either scale it up or end it depending on outcomes. The idea seems fertile. 

If it didn't work, the harms are limited. But if it did....

Feeling Chuffed

It was a great day for the ECON department at Canterbury on Wednesday. Our very own Rachel Webb, successfully defended her doctoral thesis, The Health Economics of Macrosomia. Rachel has been a part of the Department for many years, having previously completed her Bachelor's and Honours' degrees at Canterbury prior to starting her Ph.D. Eric blogged on a preliminary finding from Rachel's thesis here last year.

Rachel's successful defence comes on the heels of some other notable achievements of our recent students: James Graham has just started his doctoral studies at New York University, as one of the 26 New Zealand recipients of a Fulbright Award, and the only one with a degree in Economics; Nick Sander has just started his doctoral studies at the University of California, Berkeley; James Horrocks has recently completed his MBA at Cambridge; and Reza Baqaee is just finishing up his Ph.D. at Harvard.

These are not our only success stories by any means, but the notable thing for me about these five is that they were all in my Honours welfare economics class in 2009. The thing I have enjoyed most about teaching in our Honours programme over the past 14 years has not only been the incredible quality of our students, but also the diversity of their academic backgrounds, in large part because we have made a feature of the fact that one can major in Economics as part of an Arts, Science, or Commerce degree. James Graham and James Horrocks both did double majors in Economics and Philosophy; Nick and Reza completed combined Honours degrees in Economics and Maths, and the same class included students with undergraduate degrees in History, Physics and Finance. Keynes is famous for his statement that a master economist "must be mathematician, historian, statesman philosopher". It is too much to ask that students coming into graduate Economics have studied every one of these other subjects in detail, but the next best thing is to have a class that collectively has that breadth.