Economists spend large amounts of time evaluating existing policies or pushing for some particular new economic policy. Equally important, but less frequently done, is to say what should NOT be done and why it shouldnt be done. Of course these ‘warnings’ have to relate to a policy that is simmering below the surface and is just waiting for some intellectually challenged politician or selfish interest group to advocate it. I invite everyone to add to my following top-5 of ‘no-no’ economic policies which to my mind are in danger of becoming advocated:
1. Make mortgage interest payments tax-deductible. My country of origin – The Netherlands – implemented this policy, with the ensuing predictable rise in housing prizes and the associated large tranfers of the poor and the young (who rent) to the rich and the old (who own and have higher marginal taxes for their deductibles). Its one of the recognised mistakes of other countries and Australia is well-warned not to copy this mistake because once this mistake is made, it would take decades of political fighting to get rid of it.
2. Implement negative income taxes (also known as basic incomes) in order to osensibly solve the incentive problems with targeted welfare programs. The reason not to do this is because it is monstrously expensive: if you dont want to seriously reduce welfare levels, youre going to have to give every adult over 18 at least $10,000 AUD per year. Also, youre going to have to give everyone with dependent children a blanket subsidy (most of the disincentives come in via taper rates on the benefits for the kids), in the order of $6,000 per dependent child. Thats $32,000 AUD for your average 2-adult, 2-kids family. For the whole of Australia (some 15 million adults and 6 million kids) that would be a bill around $186 billion AUD per year. Thats 20% of GDP, whereas the current bill is about 7% of GDP. This creates two types of work disincentives. The first is that it takes away the stigma of not working since the whole population gets welfare. The second is that this additional welfare will have to be paid by additional taxes on those that work of course. Hence the plan would involve massive work disincentives for those currently working as well as opening up the attractive option to welfare for everyone.
3. Adopt a carbon trading scheme that gives all the initial emission rights to the current industry. This would effectively mean a huge transfer from the community (who implicitly owns all emission rights) to polluters, rewarding them for previous emissions.
4. Expand public-private partnership schemes whereby the government guarantees extraordinary returns to a private contractor (for instance when building a road or a bridge) in return for some up-front private funds, and where the contractor is insured against the risk of few future customers. It should go without saying that such schemes a) have huge long-run costs to the community in the form of the promised extraordinary returns, b) do away with the principle that private market parties make decisions on risk, c) coopt governments into using money from the public purse to subsidise companies just in order to make the short-run budget look good.
5. Exempt pensions from income taxes both at the moment of saving and at the moment the pension gets taken up. Such a policy would be a monumental mistake because it is firstly highly inequitable: the rich have more disposable income to save than the poor and face higher marginal taxes (thus having more to gain from tax exemptions). The more important problem with such a scheme is that it opens up incredible arbitrage opportunities that undermine the income tax system as a whole. Any bank could then offer any earner a loan with the future pension payouts as collateral – effectively bypassing income tax altogether, which again will mainly favour the rich. Such a policy would also quickly lead to a large group of stakeholders to make it politically difficult to undo it. And of course the wealth effect of such a policy will give strong incentives towards early retirement for the coming generation of workers, thereby leading to lower participation rates. Oops, Australia has just implemented this policy, making Peter Costello at a stroke an economic incompetent. I fear that Oz economists will be spending decades trying to undo ‘Peter’s Prank’.