Friday, 17 March 2023

Fringe Benefit Follies

I like the Fringe Benefit Tax.

Other places wind up in all kinds of nonsense by putting tax-preference on things if they're employer provided. It's one reason health care is messier than it should be in the US.

And New Zealand also used to have a similar problem in the era of very high income tax rates and very nice tax-free employer-provided cars. 

Tax reforms in the 80s tidied all that up. If the employer provided you with something valuable, the employer would be liable for paying tax on it as though the employer had paid you salary. 

And what exceptions there have been, as best I'm aware, have been where things get just too messy. 

Employer-provided car parks can be messy.

Suppose you have a commercial office tower with a parking level. You lease out floors to different companies. Some of the leases come with car parks; some don't. Whether you work the price of the carpark directly into the lease charge or as a separate line-item doesn't much matter. Some tenants will put a lot more value on a space than other tenants; you might want to keep things a bit opaque just to be able to better bargain on those margins. 

If a company gives one of those parking spaces to an employee, what's its value for FBT purposes? Tough to say. If you require that the commercial building put separate line items for parking so that you can make it FBTable, all the tenants with car parks will want a higher rate for their floor space lease and a lowballed car park space. Sorting it out would not be simple. What would IRD do: force each commercial building to auction off the spaces among tenants each year? If it's a small building, you're likely to hit collusion issues. 

And what do you do about spaces in places where the market clearing price is plausibly zero? 

Anyway - not straightforward. You could do something like a deemed-value charge on it. It would be a bit messy because a space right in your building might be more valuable than one you'd have to walk some distance to access, but spaces in commercial buildings can also have a lot of disamenities that make them less valuable than others - they're spaces in buildings not designed to be parking garages and so they're even worse to navigate than commercial car parks. 

So far, it's all been in the too-hard basket. I generally expect that when IRD declines to tax something, it's because it's actually hard rather than because they don't like taking peoples' money. 

And at least in principle, the FBT-exemption for employer-provided car parks creates a distortion. Imagine someone who's close to indifferent between driving in to work and taking the bus. If they have to pay for the bus out of after-tax income, but get to pay for the parking spot out of before-tax income (through a bargain with the employer that they'll have a slightly lower salary than otherwise and have a car park), that worker might choose to drive rather than take the bus just because of the tax advantage provided to parking. 

It never seemed likely to be that big of a distortion. In places where parking isn't scarce, the cost of a carpark is so close to zero that it can't matter. In places where parking is scarce, are there really that many people who receive an employer-provided car park? Among those, are there many who would have forgone a company-provided car park if they had to take a bigger salary cut to get one? What's the real effect at the margin here?

The government passed legislation this week exempting a pile of driving-substitutes from FBT. Employer-provided transit passes, e-scooters, scooters, bikes and e-bikes will all be FBT-exempt.

That feels like a fairly substantial inframarginal transfer. How many people use transit to get to work as compared to having an employer-provided car-park in places where car parks are scarce? How many people who walk to work would like to have an e-bike or e-scooter for recreational purposes and will claim that it's for getting to work? 

Remember that the higher-end e-bikes and e-scooters aren't cheap. An employer-provided one will come at a hefty tax discount for higher-earners. And where employer-provided parking is naturally limited by the number of spaces that can be found in a crowded downtown, pretty much anyone on a higher salary who'd be keen on an e-bike could enjoy the discount. 

Suppose you're on the 39% tax rate. An $11,500 e-bike contains $1,500 in GST. You have to purchase it out of after-tax income. So you have to earn an extra $18,850, at the margin, to get the $11,500 to pay for the e-bike. But your employer could give you the same e-bike for $10,000, assuming that the employer can wipe the GST as a business expense (while charging GST on the firm's final output). 

The legislation has provision for setting maximum allowable costs or for setting requirements on the FBT-exempt vehicles. Depending on how this gets set, I'd expect a whole lot of recreational e-bikes purchased for higher-earning employees rather than cash raises - regardless of whether the things get used in commuting. Who's going to monitor? 

And remember that the distortion is greatest for those on the highest incomes. They'll have strongest incentive to request e-bikes out of before-tax earnings. 

It all has me wondering whether it's better to use some deemed rate for employer provided parking, and ditch the new subsidies for employer-provided bikes. 

Or maybe we should get FBT-exemptions for shoes for those who walk to work. I've worn out a hell of a lot of shoes going up and down the Kaiwharawhara bridle path to make the trek into town. 

Thursday, 16 March 2023

Richard Meade on banking and competition

Prudential regulation requires banks to hold more capital than they would otherwise like to, so that there's less risk of default and less risk that the bank imposes bailout risk. 

New Zealand does not have deposit insurance, but some are of the view that there's an implicit guarantee of at least some sort - that the government would not let depositors be too badly hurt. The open-banking resolution mechanism would impose haircuts on depositors if there were still a shortfall after unsecured creditors and equity were burned through, and I don't think anybody really knows how big a haircut might prove politically intolerable. In that view, deposit insurance then just winds up requiring up-front payment for the insurance they're probably already getting for free. 

In any case, high capital requirements mean that banks have to hold a lot of capital; they have to compete for that capital against other potential uses of it. So you'll wind up with high nominal reported profits. And politicians will then point to high profit levels as reason for windfall taxes and the like, while ignoring return on equity. 

Those big numbers generate political demand to do things. And so it seems near-certain that the Minister of Commerce is going to ask ComCom to run a market study on the banks.

Over at The Conversation, Richard Meade raises a few points that need to be kept in mind:

  • The OCR sets a coordination point for pricing that could be considered price-fixing in other sectors; 
  • RBNZ's cheap wholesale funding during the worst part of Covid reduced the risk of meltdowns while preserving bank profitability;
  • RBNZ restrictions on entry, aimed at ensuring financial stability, also prevent competition.
He concludes with a few questions:
First, are growing bank profits due to banks acting anti-competitively, the Reserve Bank fighting inflation and preserving financial stability, or both?

Second, if bank profits are indeed excessive and due to anti-competitive behaviour, are there measures the commission could recommend and practically implement that would improve outcomes?

Finally, if bank profits are excessive, and at least partly due to the Reserve Bank doing its job, would interventions by the commission to improve competition worsen financial stability or frustrate the fight against inflation?

Answering these questions will need both the commission and the Reserve Bank to have serious conversations about how competition policy and banking regulation can be made to work together to achieve better outcomes for both bank customers and the wider economy. Little would be gained by improving bank competition if that reduces financial stability or worsens inflation.

I still think that a market study focused on barriers to entry, including account portability, could do some good. 

And I still think that that will not be what the Minister of Commerce asks for. I expect instead that the Minister wants show-trials of bank executives during the election campaign, during which they can be harangued just as the supermarket CEs were during that market study, with any report coming after the election. That kind of market study would focus on interest rate margins, mortgage interest rates and the like. 

The point would be to make it easier for the government to blame the banks, rather than bad government policy, for poor outcomes during the election - while trusting that ComCom wouldn't issue any final report until after the election. 

And the risk would be a whipping up of appetites for very bad policy and rash promises during an election campaign. The draft supermarkets report was poorly done, and created an anchor point for populist expectations - and for legislation.

If I'm right, I hope that ComCom is able to push back on any weak terms of reference and propose something that could add value rather than do harm. 

And for a bit more on New Zealand's monetary policy mess, Bryce Wilkinson's report, out today, is a must-read. 

Wednesday, 15 March 2023

Failing to clear

Every quarter, the government auctions off a batch of ETS carbon credits. Every tonne emitted in the covered sector has to be covered by an ETS credit. 

This quarter's auction failed to sell any units as the confidential reserve price was not reached. They'll roll this quarter's volume into next quarter's auction. 

We don't know what the confidential reserve price is, but spot NZUs last traded on the secondary market at $67.50. Futures contracts have prices increasing to $86 by April 2027. 

Carbon prices dropped considerably this year; they had reliably been running between $80 and $85/tonne for the second half of last year.

So what's up, other than that the bid that would have cleared the market was obviously below the reserve?

Candidate explanations:

  1. The market is no longer credible and that's why nobody's buying any. I've seen that one advanced on twitter. But if that story were true, the spot price wouldn't be at $67.50. 
  2. Large traders were trying to game the market and thought the confidential reserve price was lower than it actually was. It's potentially possible. I note that the spot price rose from $67.50 to $68.00 while I was typing (and the April 2027 price jumped to $88.95 from $86). Could be that some traders who were disappointed at the government auction have emissions that they need to cover. 
  3. Overall government policy becoming less credible. Government has abandoned a pile of really dumb policies in the climate space, but it's also done other dumb stuff like respond to a petrol excise increase with a very long-lasting subsidy for road use. That, in combination with maintaining a low price ceiling for the cost-containment reserve, might have people wondering about overall commitment to net zero. Which would have to reduce willingness to pay. But futures prices still looking a lot higher than current prices. 
  4. Price floor set back when carbon prices were in the $80+ range, and not adjusted down with the drop in carbon prices. 
Perhaps some combination of 2, 3 and 4? In that case we should expect spot prices to lift as those without sufficient reserves and who'd been banking on getting NZU at auction this quarter scramble for units to meet surrender obligations that fall before the next quarter?

I still think National and Labour should agree on the quantum of unbacked NZU that the government should be allowed to auction or allocate between now and 2050. Set that in stone, and write into future NZU contracts so that if government issues more unbacked credits than that amount, holders of existing units can sue. 

Set a carbon dividend out of ETS revenues to make higher prices more politically credible.

Then ditch the current price cap. Replace it with a price cap that follows the volume-weighted average price of carbon in carbon markets that the Climate Change Commission considers credible.

When and if the price cap is triggered, if no better way of backing units at that cap is available, government should buy and retire credits from the cheapest credible international market. It would make money on the deal - they're selling at the weighted average price and buying at cheapest price. Take the difference and stick it into the carbon dividend. Along with any excess dividends the government earns from its stake in the gentailers if high carbon prices feed through into high power prices. 

Problem solved really. And especially if you make sure that the ETS recognises credible CCS and direct air capture solutions as they come though. 

However, the pressure of necessity will be low at this auction. 

Those who have to settle emissions must file accounts in March and hand over NZUs in May. 

It is unlikely any liable parties would have left themselves exposed at this point and probably have a stockpile already. Many would also have taken forward cover fearing higher prices and will be sitting on a loss-making position now. 

As a result, traders may be willing to take a risk and test the market and the confidential reserve price at this week’s auction and even the following, even if just to push the price lower.  

However, they could be unlikely to do so for the entire year. 

In the longer term, the Ministry for the Environment’s recent forecasts of NZU supply predict a decreasing supply and an increasing demand over the coming years.

Afternoon roundup

It's been a while since last posting. The tabs...

Tuesday, 28 February 2023

Tilting at bank profits

RBNZ Chief Economist Paul Conway wants a ComCom market study into banking. He's worried about 'profiteering'.

But this is the first time the Reserve Bank, which is statutorily tasked with regulating banks, has stepped in so explicitly. It's been warning of "profiteering" in some sectors during the cost of living crisis and in the aftermath of Cyclone Gabrielle, and singled out the widening gap between mortgage and term deposit rates.

"It's a very legitimate thing for the central bank to be concerned about and to be keeping an eye on," Conway says. "It's a general warning across the New Zealand economy that now is not the time for profiteering. Now is actually the time to start paying the price, for climate change and, in this instance, for the cyclone."

Commerce Minister Dr Duncan Webb says no decisions have yet been made about the focus of the next market study. "However, I am focused on using the tool to ensure markets operate fairly for consumers," he tells Newsroom. "I am particularly interested in improving markets where the greatest long term gains can be made for ordinary New Zealanders."

I've also thought a market study into banking, and insurance, could be well warranted - but with a very different focus.

I've worried that barriers to entry look awfully high and that we may be missing out on innovations happening overseas as consequence. 

Last year I'd urged that ComCom change how it does market studies. Rather than a giant draft study that tries, and inevitably fails, to estimate weighted cost of capital and potential excess returns, start with a desk-based analysis of barriers to entry. 

Because whatever you wind up doing will depend on barriers to entry anyway.

Suppose that you really strongly believe that there are high excess profits in whatever sector. If you're right, what's stopping anyone from coming in and eating away at those profits? Remember that profits are a signal that tells other to enter. If they aren't entering, is it because you're wrong about your guess on excess profits? Or is it because there are regulatory, legislative, or other barriers preventing entry? 

When ComCom thought there were excess profits in supermarkets, and I was yelling about barriers to entry, some folks argued for KiwiGrocer as cartel-busting parallel to KiwiBank. But now we're talking about banks, and KiwiBank's already there as KiwiBank. And for whatever reason, it seems far less profitable than other banks. Surely that should give some pause.

Now banks wouldn't be the first place I'd be aiming a market study: medical services really should be first in line. But barriers to entry in banking and insurance are obvious things to look at. 

But man it's a worry if the RBNZ is wanting the thing aimed at 'profiteering'. If that's the kind of advice the Minister's getting, then expect a request for a very different market study. Instead of looking at barriers to entry, it'll be more like the Supermarkets draft study - where they raked the CEs over the coals for weeks and tied up supermarket exec teams for months in inquiries. 

If that's the request that ComCom winds up getting, then it's a test of ComCom. 

Do they indulge the Minister's preference for a highly politicised and populist bash on the banks in an election year? Or do they do the work that actually needs doing: checking whether barriers to entry, including the nonsense that RBNZ layers on top of the industry, and CCCFA regs, make for less competition than would be desirable?

Heck, RBNZ is undertaking an investigation into whether it should make it even harder for foreign banks to operate here. And Paul Conway's pointing fingers at banks for profiteering.

Jonathan has a few bits from me in his piece. It'll ungate tomorrow if you pull the /pro from the URL. But the bit including my quotes is here:

Dr Eric Crampton, chief economist at the NZ Initiative think tank, says the appropriate use of a market study would be to ascertain what barriers there are to new entrants to this country's banking market. 

New Zealand has been a slow follower on structural changes like open banking, and such easy wins as account number portability. When phone number portability was introduced in this country's cellphone market, it played a critical role in breaking apart the Telecom-Clear duopoly.

It's expected bank account portability would make it easier for bank customers to move their money (or their debt) to more a competitive bank.

What all this means is it can be difficult for a new player to get a toehold in banking here, Crampton says. "In groceries, the Commerce Commission found zoning and consenting proved substantial barriers preventing entry. In building materials, the commission’s draft study pointed to substantial barriers to using foreign-sourced building materials. In both cases, easing barriers to entry would improve competition," Crampton says.

"If the Commerce Minister told the commission to look at barriers to entry in banking, or in insurance, that could be worthwhile. The combination of barriers to entry and regulatory measures like the Credit Contracts and Consumer Finance Act may have had substantial detrimental effects on competition.

"If so, it would be great to document the barriers, their effects, and how those barriers could be eased. Is New Zealand seeing the same innovations in FinTech and InsuranceTech as are being seen overseas? Could a foreign online financial service provider easily enter the New Zealand market, or would it be impossibly hard given our scale? What are the effects on consumers?

"But I would greatly worry that, in an election year, a minister could be tempted to send the commission off on more populist tilts against the banks," he says. "Sending the commission off to interrogate the banks about interest rates and mortgage rates would be politically tempting and help divert attention from the prior government failures that led to rising rates. I would also hope that the commission would push back against proposed studies that would shed a lot more political heat than provide actual light."

It would be exceptionally disappointing if ComCom got put to populist electoral purpose this year.  

Morning roundup

The morning's worthies, as I try to trim the tabs...

Monday, 27 February 2023

Daft idea of the day

Without anyone planning it, Paris gets fed. And so does Auckland.

Not good enough for some people. 

There's demand for a national food strategy. 

It seems completely unnecessary. And ludicrous. 

If you think that poor people cannot afford nice things, there are a couple useful things you can do. Most substantially, finally fixing housing would bring down living costs. But if that didn't solve things entirely, giving poor people money lets them decide what to do with it - without screwing up the rest of the food system. 

Just look at this mess. 

This has been the state of the country's food system since the Covid-19 pandemic began, and experts are calling for a national food plan to help increase food security.

So what is a national food plan?

A national food plan is a policy that would guide food-related decisions and actions in the country.

It is an approach to understanding and addressing issues within food systems and a plan for making decisions around food.

Who would make the national food plan?

Iain Lees-Galloway of Aotearoa Food Rescue Alliance (AFRA) said ideally a food plan would be developed by all stakeholders including producers, manufacturers, retailers, food rescue and relief organisations, welfare organisations, environmental organisations, and others.

“They can bring all the various interests together and have the power to see it implemented,” he said.

It would then be led by the Government.

"Increasing food security and reducing food waste should be just as important as growing the value of our food industry. A food plan could set out that vision and present a roadmap for how we could get there,” he said.

Chief executive of Eat New Zealand, Angela Clifford, said ideally the plan would embrace treaty obligations and reflect te ao Māori.

“It should be co-designed by all participants in the food system including farmers, fishers and eaters. It should be run by a collaboration between government, industry and community.”

Go back and count the buzzwords. Then go back and tell me if you can figure out what precisely they're proposing. The buzzword-to-actual-content ratio is infinite. Not a good sign. 

I'm just glad it's being proposed now rather than last year.

A year ago, Ardern would have appointed Rob Campbell to Chair the thing before anyone had worked out details.

Now, the Hipkins-led government's trying to get rid of some of the costly unworkable stuff Ardern loaded them with and won't be keen to take on new nonsense. 

But how much would setting this up cost taxpayers?

This really depended on the final design of the plan, Clifford said.

“The real question is the cost of not implementing a plan. The current situation leaves us hungry, unwell and ecologically diminished. That’s its true cost.

“All it takes is government will and re-alignment towards our domestic food system. Given it’s an election year I would fully expect political parties to have a food security plan as part of their offering to voters. Hungry people do not make happy citizens.”

All it takes is government will, people. And clicking its heels together three times while wishing really really hard.