Lipsky’s modest suggestion

John Lipsky (1^st MD at IMF) has some excellent advice for all Governments – and though it is hosting a ‘tax summit’, I doubt our Government is open to his advice:

… increasing consumption taxation and eliminating tax exemptions that effectively subsidize debt would help raise national savings and reduce the external deficits.

These are two of Australia’s key medium term problems: we need to increase national savings (to stabilise our banks), and keep consumption growth weak to make space for the mining boom.

There are lots of changes, which may help achieve these goals, that I’d like to see in Australia. A change I’d especially like to see is a reduction of the tax bias against interest income. It’d encourage higher savings in the form of deposits, and purchases of bank liabilities — this would stabilise Aussie banks as well as Aussie household balance sheets.

Some might object that this is a tax break for the rich, but they 1/ they don’t pay much of this tax and 2/ they will take a hit to their capital as the bid comes out of property and equity markets.

re 1/ — because they can afford good advice and complex structures, rich people don’t save via deposits or fixed income – they save via negative gearing property and equity portfolios.

Over the housing boom period, this caused loans to grow more quickly than deposits, which in turn increased the dependency of Aussie banks on wholesale funding. This became a problem in the crisis, and as a result the RBA had to do some Aussie QE (the RBA took ~50bn of non-market tested RMBS onto their balance sheet, as well as vastly increasing their holdings of other assets).

Increasing the attractiveness of saving in the form of deposits – by increasing consumption taxes and reducing the taxation of interest income (to say a flat 15%) – would stabilise the banks, and (a thet margin #2 ) reduce house prices. It would lower house prices by inducing rich households to shift their portfolios away from housing and toward deposits and other interest bearing assets.

This would also have another happy side effect – it would reduce the volatility of household asset portfolios.  This in turn reduces the probability that the government will have to pay joe public’s pension — as the Government certainly would if joe blew up his savings in the property / equity market.

So my advice is that the Australian Government raise the GST and cut the tax on interest income tax to a flat 15%

you’ll get cheaper houses, lower interest rates, and more stable banks (as bank’s deposit to loan ratios will rise).