Making an exception

Here’s my AFR column for today

Making an exception

As Groucho Marx said to some unfortunate, I never forget a face, but in your case, Ill make an exception. In policy, as in life, it matters when and how you make exceptions.

If you want to free up trade, economic textbooks and our Treasury and Tariff Board (now Productivity Commission) tell us to either reduce tariffs across the board, or reduce them from the top down. And when our politicians finally bit that bullet in the late 1980s, we reaped the economic benefits.

But in Asia lots of trade reform was done by making exceptions. The Taiwanese and Koreans were highly protectionist but wanted their protected industries to export. So while they continued their efforts to keep imports out, in exporters case, they made an exception. They provided exporters with lavish access to duty drawback (tariff refunds on imports) and establishing export processing zones with completely open access to imports all to help exporters compete internationally.

As Taiwanese Minister Li observed decades later When the liberalisation efforts were made, no one had any inkling that a more prosperous growth epoch was in the making.

This pragmatic improvisation also had political implications. Channeling the rents from import liberalisation towards exporters meant that manufacturing exporters were a political counterweight to the inevitable opponents of liberalisation (for instance the less competitive manufacturers unable to export). And favouring exporters sent a message to all manufacturers dont expect too many favours if you dont learn to export.

Thus the politics of protection was gradually transformed creating a powerful organisational and political dynamic of continuing reform, not just in trade policy but elsewhere, for instance in tax and labour relations as barriers to export surfaced.

Economists were instinctively suspicious of all of this but prominent trade theorist Jagdish Bhagwati was one of several in the 1970s who hypothesised that the key to success for developing countries might be the speed and energy with which tariff protection was focused outward rather than the uniformity with which it was dismantled.

In Australia weve got a different tradition, perhaps best captured in Keatings enthusiasm for policy with long clean lines. Theres a lot to be said for it. If it had been given too free a rein in Australia, Asias higgledy-piggledy trade reform would have been transformed by our political system into piggledy reform a carnival of pork for vested interests.

But sometimes the costs of defending those long clean lines can be exorbitant, making them look like long, messy barricades to worthwhile change. For that reason, rather than give up on capital gains tax reform in 1985, Bob Hawke carved out the family home. Rather than give up on his GST dream in 1998, Howard made an exception for fresh food.

In these cases the obstacle to long clean lines of policy was political. But sometimes its economic. A holy grail of tax reform (for some) is the alignment of the top marginal personal and the company tax rates. Alignment has some appeal it narrows the scope for people to defer tax by reclassifying their personal income as corporate income. In fact the system only helps tax deferment, not ultimate avoidance you cant spend any company profits on yourself without paying them to yourself as dividends, and then you do, you pay tax on them.

And there are strong arguments in economic theory, no less for taxing capital less than labour income. And those arguments are massively strengthened for small countries which can use lower corporate tax to tap into the worlds vast capital markets.

There are plenty of other worthwhile opportunities for carve outs.

At the end of each year, the firm managing investments in my self-managed super fund sends me my funds audited accounts. Then off it goes to my accountant who audits it again. She furiously dots is, crosses ts and ticks boxes according to the Superannuation Industry (Supervision) Act and its regulations legislation with long clean lines that stretch from my tiny fund all the way to super trusts worth billions.

Then she files a statement that the fund has been audited to the standards set out in Sections 52(2)e, 52(2)d, 62, 65, 66, 67, 69-71E, 73-75, 80-85, 103, 106, 109, 111, 112, 113(1A), 121 of the Act and Clauses 4.09, 5.08, 6.17, 7.04, 13.12, 13.13 and 13.14 of its regulations.

All for . . . well nothing really. It might be time for a carve out.

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