Paying for the floods

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Today, I winced when I saw this headline: “Hockey ramps up fight against flood levy.” I thought the Opposition moved to US-style nay-saying just for the sake of it. Then I read on:

But Opposition treasury spokesman Joe Hockey is urging the Government to focus on budget cuts, and his argument is two-fold.

He says a flood levy would cause economic grief for Australian households and that cutting spending on projects like the National Broadband Network and the school building program would help free-up tradesmen who could be better used in the flood recovery.

He has a point. Re-building will require jobs and, in many cases, they will be the same jobs we use to build infrastructure. A simple way of dealing with flood damage is allowing those states receiving funds for various things to drop those projects and reallocate them for reconstruction. It is deficit neutral and also won’t simply lead to inflationary pressure on wages. Of course, it is unclear that that will be enough but it is a good place to start.

We will likely need to raise taxes too. A general levy (like that for the gun buy-back) sounds like a good and simple way to go but the one thing it does not quite do is single out the winners from the losers from the flood. “Winners?” you say. Yes, there are winners at least in theory. Let me give you one example — although I stress I have no idea of the magnitude of this — farmers. Not the farmers who lost everything although there existence is the point. No, the farmers who didn’t. We are told that the flood will lead to higher food prices. Those revenues are going somewhere. What that means is that there will be some short-term rents earned. What you want to do is tax those rents.

One thought I had was to put the GST on fresh food (at least for a year). As John Quiggin stressed a decade ago, food expenditures are inelastic so whether you leave them out of the GST it is nondistortionary. Same applies for when you put the GST on them. In this case, that means it will skim off the rents being earned as a result of the flood (and indeed the drought) by agriculture that fortunately was out of the way of rising waters. I’m not sure this will do the trick — it is a theory — but if it does I’d love to see a politician sell that!

11 Responses to "Paying for the floods"
  1. If food demand is inelastic then the GST will just increase consumer prices and be a non-distrotionary way to increase Government revenue.  But it will not extract the rent from food producers.  You should propose a food superprofits tax. Or some kind of royalty for using soil nutrients which belong to all Australians.

  2. @Sarah Good point. Of course, if it isn’t perfectly inelastic that wont hold and perhaps it will do the rent extraction function to some degree.

  3. Josh,

    I agree that the BER in blood affected areas should be slowed to reduce demand for builders etc but surely the trades and labourers used in the NBN rollout aren’t in high demand for the flood recovery task and, to the extent that they are, surely there are synergies between the NBN and infrastructure rollout that can be exploted (eg subterranean electrical cables co-located with fibre optic cable).  Similarly, where the local telephone lines have been wiped out, it doesn’t make a lot of sense to replace the copper with copper when fibre optic could be rolled out at much the same cost.  Surely the issue about the NBN is not whether it sghould continue to be rolled out but rather, wehther it can be rolled out in a manner that complements the flood recovery process.

    Re the levy, farmers often need the high prices in good times to offset the lack of income in bad times – to cut back the gains in the good times runs the risk of making some farming ventures unsustainable – that said, they do get significant subsidies in the bad times so maybe a rent tax type levy (as a permanent feature to smooth farm incomes) isn’t such a bad idea.  As a future measure, perhaps it would be better to encourage insurers outof the flood market altogether by offering a national scheme funded by an insurance levy or even a levy on rates – insurance companies could still offer plus coverage such as accomodation support etc but it take away some of the moral hazard we currently have with Govenments and hilanthropy effectively covering those people who didn’t pay for insurance and , in effect, penalising those that did pay.  I have no problems with people building in flood prone areas provided they are aware iof the financial risks of doing so and those risks are factored into their decision making – however when we effectively insure these people when they do get flooded through aid and Government grants, this economic driver is significantly diluted (and yes, i realise that my insurance/rate levy idea undermines the incentive effect however there is no reason whty the levy/ rate counldn’t be higher for flood prone properties).

  4. Surely a time of higher food prices is when politicians are least likely to put a tax on food.
    Also, whether it would work as a means of funding the States to pay for flood assistance would depend on how the flood assistance payments are treated in the calculation of GST shares. If they are included in the calculation, then it doesn’t matter in terms of state shares whether you give the States more GST or flood assistance payments. If they are not included, then the distribution would be different. I am assuming that you are not proposing to change the distribution of the GST.
    It would be very hard to unwind. At the end of the year, you would have to go through the whole process of 2000 again, trying to work what is subject to GST and what is not. I guess this is a good thing, as it might lead to the change being permanent.

  5. Replying to Joshua’s comment

    If food demand isn’t perfectly inelastic, the GST results in some substitution away from food purchase, and reduces the amount of rent available to extract.  But doesn’t actually extract the rent. Sorry to be picky. Politicians cannot be expected to communicate anything which career economists don’t understand 😀

    @Sam I like your comments on GST distribution!

  6. Don’t forget the Commonwealth needs the agreement of all six states to raise the rate of GST.  How likely would it be to get it?  And how much political damage would it sustain while trying to?

    Economic virtues aside, I don’t think any government would contemplate this for more than a few seconds.

  7. There is another way of looking at the rebuilding and that is to consider it an early replacement of infrastructure.
    http://cscoxk.wordpress.com/2011/01/25/early-infrastructure-replacement/
    We fund infrastructure from savings or with interest bearing loans.  Here is an outline of how this can be done
    http://cscoxk.wordpress.com/2011/01/21/funds-for-queensland-flood-relief/
    If interest free loans are given without time limit and with some discretion on how the funds are used (that is a new railroad line might be built in a different place rather than a replacement) then prices will cause the system to slow the rate of replacement to match the availability of resources.
    Interest on loans is an accounting device to put a price on time and it is called the opportunity cost.  This is a concept that is not needed for this situation – nor for most infrastructure expenditure.  Infrastructure we are going to build should be built with interest free loans.

  8. Sarah is right that if food demands are inelastic that the tax will be passed onto consumers.  If demands are not perfectly inelastic but nearly so then most effects will be passed onto consumers. Its in your microeconomics text Joshua.

    So I think that (ignoring other expenditure cuts) the choice is between taxes and bond-financed borrowing.  It seems to me there are some arguments for the latter. Borrowing will have a smaller deflationary effect on the economy than a tax hit. In addition borrowing spreads capital costs (rebuilding roads, bridges etc) across a wider range of tax-payers.  Of course blowing out the deficit will really make Hockey scream.

    On a different issue. I wonder why I cannot comment on your blog from my IPAD?   The Captcha software is a pain.

  9. When I think about it more, demand for fresh food isn’t inelastic so the old Quiggin idea is probably false.
    Yes that means some distortion.
    Anyhow, my point was more about taxing farmer’s rents than the precise mechanism. Same political issues apply.

  10. A sudden surprise and temporary tax on food would hardly affect the supply of fresh food now as the crops are in the ground.

    Who bears the cost is then determined by how elastic demand is.

    But might lower investment due to raised sovereign risk.

    Is it really a rent to be able to supply food in a time of shortfall? Opportunities for gouging mean more reliable supply.

  11. there has been both private and public capital investments destroyed here

    for me, public debt is not a dirty word and a lot of the public infrastructure that will make returns to the public covers over a number of decades should be funded by long term borrowings, rather than upfront via taxes

    that is not the best way to deal with potential labour shortages and wages pressures!

    and the new liquidity arrangements for banks mean there is a captive mkt!

    i think there is a lot of policitcs here – both ladies suring up votes in Qld post the Fed election catastrophe on the mining tax

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