Today the Treasury advised that it no longer calculates an annual rate of return on the portfolio of state owned enterprises as a whole. It no longer publishes an annual portfolio report (APR).
Source: Treasury response to Official Information Act request by Jim Rose, 14 January 2016.
The Treasury regards the crown portfolio report which contains performance indicators on the state owned enterprises portfolio as a whole as too resource intensive.
The Treasury prefers to be more forward-looking in their reporting on a quarterly basis to the Minister of Finance. Unfortunately, the Treasury refused to my requests for access to this forward-looking reporting to the Minister of Finance on commercial-in-confidence grounds.
The forward-looking approach to state-owned enterprise performance is now only by the Treasury and the Minister of Finance. No one else has access to this financial performance information.
It is no longer possible to say using a figure calculated by the Treasury whether the portfolio of state owned enterprises as a whole are a good return to the taxpayer or not. Individual annual reports of the state owned enterprises can be reviewed but the portfolio wide rate of return is no longer available from the Treasury with the associated credibility of the same.
A common argument against state ownership is that as a whole government ownership is a bad investment. Specifically, the portfolio of state owned enterprises struggle to pay a return in excess of the long-term bond rate.
A common argument for continued state ownership is the loss of the dividends from privatisation. The vulgar argument such as by the New Zealand Labor Party and New Zealand Greens is if a state owned enterprise is privatised either partially or fully, the taxpayers no longer receive dividends. The fact that the sale price reflects the present value of future dividends is simply ignored.
Governments are so bad as business owners and so incapable of running a commercial process free of politics that governments cannot even sell a state-owned enterprise for a good price under the full glare of the media and public.
A reply to the loss of dividends argument is the dividends from the portfolio as a whole do not repay the government debt incurred to fund capital infusions into state-owned enterprises both when initially established and through time. In that case, it is better to leave your money in the bank than in the state of enterprise.
John Quiggin often criticises privatisation on the grounds that state owned enterprises can invest at a cheaper rate because they are financed at the long-term bond rate:
In general, even after allowing for default risk, governments can borrow more cheaply than private firms. This cost saving may or may not outweigh the operational efficiency gains usually associated with private ownership.
It is not possible to scrutinise that argument without an annual rate of return on the portfolio of state owned enterprises as a whole to see if it is true at first pass at least. As the Treasury no longer calculates a rate of return on the portfolio and taxpayers’ equity, that debate comes to something of a crashing halt in New Zealand.
If these state owned enterprises were privately owned and listed on the share market, investors would just look at trends in share prices for daily measure of expected future profitability.
The fiscal case for privatisation must be assessed on a case by case basis. It will always be true for example that if a public enterprise is operating at a loss, and can be sold off for a positive price with no strings attached, the government’s fiscal position will benefit from privatisation.
Various early ventures in public ownership, such as the state butcher shops operated in Queensland in the 1920s (apparently a response to concerns about thumbs on scales) met this criterion, and there doesn’t seem to be much interest in repeating this experiment.
In most sectors of the economy, the higher cost of equity capital is more than offset by the fact that private firms are run more efficiently, and therefore more profitably, than government enterprises.
But enterprises owned by governments are usually capital intensive and often have monopoly power that entails close external regulation, regardless of ownership. In these situations, the scope to increase profitability is limited, and the lower value of the asset to a private owner is reflected in the higher rate of return demanded by equity investors.
Quiggin is wrong about government enterprises have been a lower cost of capital because it contradicts the most fundamental principles of business finance as explained by Sinclair Davidson:
…it is clear that the Grant-Quiggin view violates the Modigliani-Miller theories of corporate finance. The cost of capital is a function of the riskiness of the investment projects and not a function of a firm’s ownership structure.
How the cash flows of a business are divided between owners and creditors does not matter unless that division changes the incentives they have to monitor the performance of the firm and keep it on its toes. Those lower down the pecking order if things go wrong such as owners have much more of an incentive to monitor the success of the business and lift its performance.
Capital structures of firms, the property rights structures of firms, matter precisely because they influence incentives of those with different claims on the cash flows of the firm.
Having to pay debt disciplines managerial slack and ensures that free-cash flows are used to repay debt (or pay dividends) rather than be invested in low quality new ventures. Having to borrow from strangers such as banks ensures regular scrutiny of the soundness and prospects of the company from a fresh set of eyes. Capital structures made up of both debt and equity keeps the firm on its toes.
Unfortunately, in New Zealand it is much more difficult to review the arguments for and against the current size and shape of the state owned enterprise portfolio as for example summarised by John Quiggin:
Technologies and social priorities change over time, with the result that activities suitable for public ownership at one time may be candidates for privatization in another. However, the reverse is equally true. Problems in financial markets or the emergence of new technologies may call for government intervention in activities previously undertaken by private enterprise.
In summary, privatization is valid and important as a policy tool for managing public sector assets effectively, but must be matched by a willingness to undertake new public investment where it is necessary.
As a policy program, the idea of large-scale privatization has had some important successes, but has reached its limits in many cases. Selling income-generating assets is rarely helpful as a way of reducing net debt. The central focus should always be on achieving the right balance between the public and private sectors.
This balancing of public and private ownership is more difficult in New Zealand because portfolio wide rates of return are unavailable unless you calculate them yourself. That must be labour-intensive given the Treasury thought it was too labour-intensive for it to do for itself.
An obvious motive to start a review the extent of state ownership is the portfolio is performing poorly. That warning sign is no longer available because the crown portfolio report is no longer published.
One way to fix an underperforming portfolio is to sell the dogs in the portfolio. One of the first ways owners notice dogs in their portfolio is the portfolio not returning as well as it used too because of the emergence of these dogs so further enquiries are made and explanations sought.
Taxpayers, ministers and parliamentarians are all busy people with little personal stake in the rate of return on the state owned enterprises portfolio.
Taxpayers, ministers and parliamentarians will all first look at the portfolio wide rate of return to see whether more detailed scrutiny of individual investments is required. That quick check against poor value for money and trouble ahead is no longer available on the state owned enterprises portfolio in New Zealand.
The Left talks about poverty traps arising from means testing of social insurance and welfare benefits but denies flatly that high marginal tax rates will affect the labour supply of the rich and willing to do.
Things are pretty grim when your ideas for fixing child poverty by throwing a lot more money at the problem are easily outclassed by the Greens in terms of economic rationale, fiscal sense and political practicality.
But that is the case for Gareth Morgan’s proposals for a universal basic income for New Zealand. His proposal for a universal basic income funded by comprehensive capital tax make much less sense than those of the Greens for giving the in work family tax credit for those do not work but are on a welfare benefit.
The Greens have a far superior proposal for reducing child poverty and a far better chance of getting it implemented in parliament. Their proposal is simply to introduce a parental tax credit and give the in work tax credit to those currently on the benefit to increase their incomes.
Gareth Morgan’s solution to child poverty is to give billions of dollars to adults not in poverty and leave those who are in poverty worse off under the universal basic income. It is obvious which of these is more likely to attract political support and provoke resistance from taxpayers and political parties willing to court those are opposed to great big new taxes.
One of the economic reforms in the 1980s and 1990s that saved the welfare state was more efficient taxes and more efficient government spending. The targeting of government social spending reduce growth in the overall tax burden and therefore the political resistance it provoked.
Government spending grew in many countries in the 20th century because of demographic shifts, more efficient taxes, more efficient spending, a shift in the political power from those taxed to those subsidised, shifts in political power among taxed groups, and shifts in political power among subsidised groups. Sam Peltzman argues that:
governments grow where groups which share a common interest in that growth and can perceive and articulate that interest become more numerous.
The median voter in all countries was alive to the power of incentives and to not killing the goose that laid the golden egg. After 1980, the taxed, regulated and subsidised groups had an increased incentive to converge on new lower cost modes of redistribution.
More efficient taxes, more efficient spending, more efficient regulation and a more efficient state sector reduced the burden of taxes on the taxed groups. Most subsidised groups benefited as well because their needs were met in ways that provoked less political opposition.
Gary Becker and Casey Mulligan in Deadweight Costs and the Size of Government (NBER Working Paper Number No. 6789) concluded that flatter and broader taxes encourage bigger government. This is because taxpayers offer less resistance to increases in flat tax rates than to more onerous and less efficient forms of taxation. Any decline in the resistance of taxpayers to taxes leads to larger governments since an endless number of groups lobby to divide up the large revenue base.
An inefficient tax system or spending program from the standpoint of optimal tax theory can improve taxpayer welfare this so-called inefficient system creates additional political pressure for suppressing the growth of government. Inefficient taxes do not raise much revenue and therefore do not support a large sized government.
A switch to more efficient taxes through tax reforms allows governments to raise the same amount or larger amount of revenue for the same level of political resistance from taxpayers. This is because less revenue and output is wasted by discouraging labour supply, investment, savings and investment in capital with high marginal rates of tax on narrower tax basis.
The rising deadweight losses of taxes, transfers and regulation all limit the political value of inefficient redistributive policies. Tax and regulatory policies that are found to significantly cut the total wealth available for redistribution by governments are avoided relative to the germane counter-factual, which are other even costlier modes of redistribution.
Everyone can gain from converging on more efficient modes redistribution. The tax burden is less than otherwise. Government spending is more than a wise because taxes are raised with less deadweight social costs.
An improvement in the efficiency of either taxes or spending reduces political pressure from taxed and regulated groups for suppressing the growth of government and thereby increases total tax revenue and spending because there is less political opposition. Improvements in the efficiency of taxes, regulation and in spending reduce political pressure from the taxed and regulated groups in society.
The post-1980 reforms of Thatcher, Reagan, Clinton, Hawke and Keating, Lange and Douglas and others saved the modern welfare state. Their moves towards more efficient taxes and better targeted social spending did reduce growth in government spending but also prevented even larger cuts to social spending since 1980 at the behest of the increasingly restive taxpayer.
Social spending growth did temper after 1980 but the level of spending was larger than otherwise because of the extra revenue raised through more efficient taxes – more efficient taxes which provoked less political opposition.
More efficient taxes, more efficient spending, more efficient regulation and a more efficient state sector reduced the burden on the taxed groups while still supporting extensive but more tempered social spending.
Governments everywhere hit a brick wall in terms of their ability to raise further tax revenues. Political parties of the Left and Right recognised this new reality. Gareth Morgan has not when he proposes a great big new tax to fund his universal basic income.
Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies – Groucho Marx
Which has more political legs? The Greens’ proposal to raise taxes by $1 billion to fight child poverty or the proposal by Gareth Morgan to raise taxes by 10 times that and have less impact on child poverty?
The current and future governments of New Zealand have enough on their plate to work out how to fund a universal old age pension and health spending without giving away billions of dollars to the non-poor through an universal basic income.
One of the many drawbacks of the universal basic income is it will induce the recipients to cut back on their labour supply. There are studies of this labour supply effect through the study of what happens when people win the lottery – either the big one or a small prize.
Winning the lottery is the equivalent of winning an annuity equal to whatever annual income you can get it current low interest rates and share market returns.
A surprisingly number of people on the Left who deny that taxes have significant labour supply effects will nonetheless accept that winning the lottery will induce people to quit work permanently or cut back at least. The most likely reason is they buy lottery tickets too.
A study has just come out on the labour supply effects of winning the Swedish lottery. The sample in this study was really big: several million Swedish lottery winners.
Sweden seems to be like the USA in that both are awash with interesting economic data to the many other countries do not collect. Moreover, they were able to study these Swedish lottery winners over a 5 to 10-year period. Labour supply detail at that level is like going to heaven for an empirical labour economists.
The researchers found that in common with a previous study of the labour supply of lottery winners after their win that there were
modest reductions in labour earnings suggesting every dollar of universal basic income would reduce labour earnings by roughly $0.11.
The new research also found productivity losses of $1.40 for every hundred dollars of lottery winnings and that the partners of the lottery winners cut back on their labour suppliers well. No surprise there. Taking all these labour supply effects into account, our researchers concluded that:
every dollar won in a lottery reduces lifetime after-tax labour earnings of winners by $0.10-$0.20.
All in all, the universal basic income will be a negative productivity shock built on a negative productivity shock. First of all, there is the great big new tax to fund the universal basic income. Then the recipients of the basic income will cut back on their labour supply further compounding the massive social costs of the universal basic income.
A universal basic income is a bad idea from start to finish and that is before you consider the many advantages of encouraging people to work for their living. Working for your living is a central expectation of adult life.
UPDATE: what is the magnitude of this labour supply drop from universal basic income? The usual labour supply effect of a recession as recently summarised by Richard Rogerson is as follows:
Consider by way of comparison the labour market fluctuations associated with the business cycle. Going from normal times to a fairly severe recession is usually associated with a drop in total hours worked of about 3 percent.
A universal basic income will push the New Zealand economy into recession off the back of labour supply effect from the windfall increase in incomes alone. That is before you consider the massive productivity shock pushing the economy down further through a massive increase in the taxation of capital, which is the most inefficient form of taxation.
In work tax credits for families in Working For Families certainly makes a difference to the after-tax, after government transfers living standards of the family on an average wage.
Why Evolution is True is a blog written by Jerry Coyne, centered on evolution and biology but also dealing with diverse topics like politics, culture, and cats.
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