There are many reasons why the proposed flood levy is a bad idea, including the following:
- It’ll reduce the government’s popularity even further;
- The public will reduce voluntary donations to flood victims;
- Consumer spending will drop, placing further pressure on retailers;
- There’s a possibility the temporary levy will become permanent;
And so on. These objections to the new tax have already been widely discussed, so there’s little point in explaining them further here. One big financial problem with this and any other sort of levy, however, relates to the relative cost of borrowing between the government and households. Put simply, the 0.5% to 1.0% flood tax is not just unpopular, it’s also economically inefficient. Here’s why.
Most of the households at which the tax is aimed, i.e. those earning $50,000 per annum and more, are likely also to be paying off a home mortgage. At the moment, the annual variable interest rate for such loans is probably between 7.5% and 8%, with another 50 basis points of rate rises likely to arrive before the calendar year is done.
Because households can pay down a variable home loan (overwhelmingly the most common choice for Australian borrowers) at any rate they like above the agreed monthly minimum, the interest rate they’re charged is effectively their cost of funds for all expenditures. That is, if they choose to forgo, say, $1000 of discretionary expenditure, then they save 7.5% to 8% of this in annual interest.
Precisely because of its ability to tax citizens with impunity, the federal government’s borrowing costs are considerably lower than those pertaining to the average household. Right now, for example, Commonwealth 10-year bonds are trading at a yield of 5.51% per annum.
This means that if he wants to, Treasurer Wayne Swan can borrow money for 10 years (the approximate life of the average home loan) at a rate 2.5% to 3% less than us poor households — yet instead of taking advantage of this glaringly obvious interest rate differential, the government’s moderate financial burden from the floods is being foisted on to the public.
What Swan is doing here is a bit like a consumer who has a credit card he or she never pays off, plus a housing loan with a redraw facility. As the credit card probably costs between 12% and 20% per annum, the consumer should avoid using it in favour of the much cheaper form of finance also available (i.e. the housing loan).
Admittedly, there are people out there who do make silly decisions with their personal finances, and thereby pay a lot more in interest than they should. It’s sad, however, that such financial idiocy should make its way into the federal Treasurer’s office.
In a nutshell, while the government can borrow so much more cheaply than the households it’s supposed to assist, there is no good reason why the flood costs should be funded at personal home mortgage rate — which is exactly what, for most people, the proposed levy represents.
Oh Tom, what a waste of time. As you can see from this being the first comment Crikey isn’t the place for that kind of clear thinking or economic rationality.
Hi Tom,
I think after the last election where the mainstream media and the coalition got away with their fibs about how much the Australian Government borrows each day etc: Labor are now afraid of the free punches and ammuntion that will supply.
The Levy also serves up the perfect opportunity for Labor to dump some of their unpopular green initiatives.
The Treasurer can borrow money at low rates but he can also provide loans to flood victims at a zero rate. If 5% is better than 7 or 8% then 0% is even better.
Provide flood relief through interest free loans repaid from future taxes of the people getting the loans is a more economically efficient way to allocate money. The reason is that people who get the loans will be careful how they invest them and they will not take them out if they do not need them. The problem with a levy or with the government supplying funds is in the efficient spending of the funds. If a house is to be rebuilt then the person who is paying for it is the best one to decide what house and where it is going to be built. When governments allocate funds they think they should have a say in where and how the money is spent and we get the fiascos of pink batts and the inefficiencies of schools computer programs.
The way to solve the spending problem is to give the decision on how to spend to the people most involved and the way to do that is to provide interest free contingent loans. That is the loans will be repaid from taxes when the people involved are earning money again.
This way we will not only get efficient spending of money but it will cost the community less because the money used is at 0% not 5%. It has been done before – most notably by the early Commonwealth Bank which used the approach to pay for the First World War without imposing a heavy interest burden on the population.
“It’ll reduce the government’s popularity even further; The public will reduce voluntary donations to flood victims; Consumer spending will drop, placing further pressure on retailers; There’s a possibility the temporary levy will become permanent”.
Enough said!
Does this line of reasoning apply only to the proposed flood levy ?
Shouldn’t it be applied to all taxes that reduce mortgagees’ discretionary income ?
I thought not.