Tax raids are a sign politicians are growing up – Fat Tail Daily

My son peed all over the toilet yesterday. Not just the toilet seat, the toilet.

It’s not ideal. But it is an inherent part of growing up.

Of course, some people never advance beyond this stage. But it is nevertheless an advance from nappies. Even if it causes a spectacular mess.

The same thing applies to Australian politics. The tax raids that are causing political and economic chaos are actually good news…in a very good disguise.

Of course high taxes are not the optimal outcome or policy setting. Nobody, except perhaps civil servants, would think so.

And yet, admitting you’ve got a problem is a step forward, isn’t it?

Trial and error is part of politics

We’ve been warning about government debt since our ‘Australia in the Red’ event almost 20 years ago. At last, politicians are trying to do something about it.

Politicians don’t like raising taxes. They know it’s unpopular.

And yet, they did it anyway.

There can only be one reason why. An implicit acknowledgement that the government is spending too much and in too much debt.

Even if the solution is the wrong one, this is an astonishing admission.

Well, politicians give it lip service all the time. But now they’re actually doing something about it.

Like my son, they are doing the wrong thing. But they have realised that something must be done.

You can’t pee on yourself forever. Peeing on other objects is the next logical progression for a two-year-old.

Trying to rebalance fiscal policy by raising taxes is a natural step for a politician. It’s going to make the underlying problem worse. But it’s still a marker of progress in the long run.

How many great journeys begin with a step in the wrong direction?

Governments only do the right thing after exhausting all other options. You can’t expect politicians to just do things properly at the outset. They have to actively learn the hard way first.

And then there are the voters. They need to realise there is no free lunch.

At least one generation has lived off the Australian government’s borrowing capacity without realising it. Now they’re finding out the hard way that this has a limit. And an interest bill to boot.

Australia’s leading politician, Pauline Hanson, reckons the budget is a ‘shit sandwich. And now we’ve got to eat it.’

But it’s just reality, biting. We live in the age of consequences. These tax hikes were baked in, back when government debt became acceptable again. That’s why we bothered warning about it, back then.

History rhymes and we’ve
been here before

Labor Party history is full of lessons learned the hard way…and then forgotten.

Remember the ‘recession we had to have?’ An admission that the business cycle can be a good thing.

Imagine a politician saying that today!

Or UK Labour Prime Minister Callaghan’s astonishing admission:

‘We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step.’

Yes, we’ve discovered how disastrous Keynesian economics and Modern Monetary Theory are before. Plenty of times, even periodically, throughout history. But we keep trying it out anyway.

It’s not just Labor, to be fair. The Reserve Bank of Australia forgot what causes inflation in 2022. They pulled the Phillips Curve out of the drawer of disproven economic theories instead.

The RBA promised not to hike rates without wage growth. But this presumes inflation is everywhere and always driven by wages. Yet that relationship was debunked by Callaghan’s experience of high inflation and high unemployment, to name but one example.

It’s not just Australia, either. The Dutch have proposed an unrealised capital gains tax, and the French have proposed a wealth tax. It doesn’t matter how badly these have fared in the past. They always come back eventually.

It’s embarrassing that we must periodically re-learn these lessons. But…

It could be worse

Fiddling with tax rates might seem like a nightmare. But you should count yourself lucky. Other countries are pursuing even worse ways to try and deal with their fiscal reckoning.

Some want to completely ignore the bond markets that finance their debt. Others still think they can print money. Capital controls are another traditional option.

In the UK, supermarket price controls and nationalisation of industries are on the table again.

Believe it or not, some potential prime ministers in the UK are proposing a shift to Australia’s tax system as a solution. He clearly hasn’t been reading our news media!

Australia’s tax system pools earnings from work, capital gains, and distributions into a single pot and then taxes them progressively. Some of those forms of income get favourable treatment. But the point is that your progressive rates apply to the pool of assessable income.

This is just one way of doing things. To be honest, I thought it was the norm. But having to comply with inheritance tax laws in five jurisdictions at the same time has taught me a lot recently…

The UK, Japan and Germany have a fixed investment income tax rate, around 25%. And in Germany, your banks and brokerages simply withhold that tax automatically. You don’t even need to file a tax return if you simply live off this investment income and nothing else.

The point is that 25% was in line with Australia’s tax rates under the capital gains tax discount. Under Labor’s proposals, our tax rates are suddenly miles higher than our peers’.

How Labor’s tax plans will implode

There’s a simple reason I’m not worried about Labor’s current tax proposals. They are too bad to last.

Australian tax rates would be so high that hundreds of thousands of Australia’s highest-earning and most productive workers would quit their jobs. This would cause GDP and tax revenue to plunge, fast.

Why the exodus?

If your investments generate significant income, your effective tax rate for staying in work would be absurdly high.

An investor who generates $45,000 in investment income would pay 30% tax on the first $90,000 of workplace income. That’s because your investment income uses up your tax-free and low-tax allowances.

Many won’t bother working if 30 cents of their first dollar in income goes to the government. And at higher incomes, it only gets worse.

This is why the likes of Japan, German and the UK tax labour and capital separately. To avoid the disincentive for rich people to work at all.

Australia’s tax proposals create a choice between investing and working. No point doing both, anymore. Your marginal tax rate will be too high.

Self-funded retirees will simply quit work. This will undermine the tax base far more than the tax increase generates. Not to mention the secondary effects of people leaving work.

The night is darkest before
filing your tax return

We are at the point where politicians must actually do something about the budget deficit. The debate has now shifted to what it is they should do. Australia is pursuing yet another self-defeating solution. But at least the debate is about the right topic.

For now, there is a simple way to respond to Labor’s tax raid: add more risk to your portfolio.

The proposed changes disadvantage mediocre returns in the way they adjust for inflation. But these rarely occur in the high-risk small-cap space.

Those capital gains can also take years to play out. By which time, we’ll have more tax reform to deal with the current mess.

That’s why we’re launching the ATLAS Project.

Because ATLAS didn’t shrug under unfair conditions. He didn’t do a runner like John Galt.

He fought to get rich despite the government, like Dagny Taggart and Hank Rearden. They did it by taking on risk.

You can too.