Can big government mean fewer taxes?
Some people want lower taxes and governments to privatise businesses. But profits from asset ownership are a revenue source that can reduce tax needs.
Note: It is the last day of the financial year in Australia.
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Saudi Arabia’s total tax revenue was less than 2.3% of GDP in 2013.
Not 23%.
Just 2.3%.
The average of the Organisation for Economic Cooperation and Development (OECD) countries—essentially a club of rich countries—was about 33%, or 14 times higher.
But this doesn’t mean that the Saudi Arabian government had little revenue or its spending was not a large part of the economy.
No.
Government spending was over 30% of gross domestic product (GDP) and is often higher than many OECD countries, hitting 35% in 2017.
How can this government spend over 30% of GDP and tax less than 3% of GDP?
The short answer is that the state owns a very profitable oil business.
As its major shareholder, it enjoys a large profit stream each year of $100-150 billion (USD), or about $7,500 per citizen of the Kingdom.
So the “socialism” of Saudi Arabia and other resource-rich nations—in the form of state ownership of profitable enterprises—allows them to tax far less.
The more that governments own productive income-generating enterprises, the less they need to tax to raise revenue. They don’t even have to run them. Just be a shareholder.
This is not a secret.
Many state and federal governments have investment funds to buy part-ownership of private businesses as a funding method. This is the whole logic behind sovereign wealth funds.
Australia’s new Housing Australia Future Fund (HAFF) bought $10 billion worth of assets, predominantly equity stakes in domestic and international businesses. They hope to use the profit share to pay for housing subsidies rather than taxes.
Of course, they could have just built homes instead. Homes are also businesses.
Norway’s government takes a 30% ownership stake in all oil businesses via its investment fund Petroro and owns 100% of Equinor, which produces 70% of all oil on the Norwegian shelf. This provides a profit stream to the government worth tens of billions each year.
Owning a 30% portion of Australia’s private banks, with their more than $30 billion in profits last year, would have provided $10 billion in public revenue. You could buy this equity for about $115 billion and it would provide an 8% return. A fair chunk of our major banks’ equity is probably already owned by governments via various global sovereign wealth funds.
There is talk of privatising Sydney Water, a public entity that has pumped hundreds of millions in revenue to the New South Wales government each year. Why sell income-producing assets?
The IMF is finally saying that public assets need to be considered. This makes total sense. If we want to obsess about public debts, at least look at public assets too! You wouldn’t judge a private business by one side of its balance sheet only.
It’s an open question about the degree to which governments should put money at risk for equity to fund strategic industries.
In principle, I think it is much more equitable and efficient than grants and subsidies.
But what this shows is that calls to privatise businesses to “save the taxpayer” have things exactly backwards.
The real economic questions about privatisation or public ownership are not about ownership. They are about risk and incentives. You can part-privatise while retaining ownership shares to change administrative incentives without actually changing ownership structures very much.
Queensland recently privatised its land titles office. But of course, this ruse merely demonstrates the same point. It was privatised but bought by the same government’s investment fund. A neat accounting trick. But no different from any other.
This is how I described the accounting perversity in a paper with Tim Helm:
Selling government businesses is commonly thought to generate additional cash revenue for general spending. It is also commonly thought that buying businesses through sovereign wealth funds can generate a risk margin over cash, and thus improve the long-term public budget position via differential returns.
How can selling a business for cash improve the budget position yet the reverse trade of buying a business with cash also have the same effect?
The contradiction is due to another ownership illusion. Governments do not record accurate balance sheets, and the capitalised value of revenue from operations is not generally reported. But when a business is held in a sovereign wealth fund or other such financial entity its capitalised market value is regularly estimated and reported.
…
The Australian states of New South Wales and Victoria have in recent years privatised their land titles office (LTO) operations. The LTOs manage the property titles system and charge fees to users to record property sales or access records, generating a cash surplus. These privatisations effectively swapped ownership of a non-cash asset in the form of business equity for ownership of a cash asset, the sale proceeds.The sales were described by government agencies as unlocking capital for investment with the upfront proceeds “recycled” into funding new infrastructure (DTF 2018; NSW Treasury 2017). Both states also run investment funds that invest in, amongst other things, company ownership in the form of direct ownership or equity shares.
In principle, each state could have sold their LTO to the investment fund of the other state. Prior to this each state would have owned cash and its LTO business. After the ownership swaps, each state would have owned the cash proceeds and the other’s LTO business. Reported net assets would increase for both, since the LTO revenue stream would be valued more highly when owned as an investment than as a government operation. Despite the ownership swap making no difference to combined revenue or costs, each state would appear better off economically.
I have written before about how governments like to own Australian houses as a revenue source. But just foreign governments.
Even though in this report I showed that owning the public housing stock is as good as owning other assets for their income-generating potential.
These economic returns are evident in the value of LAHC’s property portfolio, which increased from $32 billion in 2012 to $51 billion in 2020, a 7.8% compound return. LAHC also makes around $800 million per year in rental income from its property portfolio. LAHC’s balance sheet is larger than any of Australia’s largest private housing developers.
Details matter
Once you take the idea seriously of governments owning productive assets, even without managing them, the question shifts to practical ways of how to get ownership stakes. In particular, how do you ensure that you end up owning productive and profitable businesses and avoiding owning failing businesses?
Here are a few ideas.
1. Replace most grants with equity injections
A lot of what governments do is grant money for fixed purposes. But when supplying funding for research or to for-profit businesses, grants could be crafted as equity injections where possible. For the public agency, there is no cost from this change, only possible gains.
2. Take equity stakes as a return for public resources
For example, a banking licence can be structured as a required equity contribution to the federal government. Why not charge for banking licenses via, say, a 10% equity stake? That would generate $3 billion in returns per year for the Australian public from that alone, while essentially requiring no government administration. Banking with the Australian dollar is an industry that is built on public institutions. Why not take some upside?
When upzoning property, the new property rights can be sold, or governments can provide land in joint venture projects. This is exactly what Melton Council did—providing land for a joint-venture housing subdivision with Lendlease. The council now has a robust revenue stream from their profit share. I wrote about that project and other public housing developments here.
The Norwegian government takes equity stakes in all the private oil and gas companies operating in their territory. It contributes funding to develop oil and gas operations and earns a profit share. This article argues that the Norwegian government’s ownership stakes in otherwise privately owned oil and gas companies “may be seen as a form of taxation”.
Given Australia’s enormous resource base, this type of activity could be done too. However, this method of contributing funding to new resource development as an equity injection does expose the government budget to additional risks in the resource sector, especially given the cyclical nature of resources.
3. Counter-cyclical central bank purchases of domestic equities
The Bank of Japan during the late 2010s (and during COVID) accumulated nearly half a trillion US dollars (¥45 trillion) of equities to become the largest owner of Japanese listed equities (beating out the Government Pension Investment Fund).
Since the cost of funding for a federal government (in its own currency) is usually the lowest of any actor in the market, it makes a lot of sense to counter-cyclically accumulate risky assets using cheap debt.
Bizarre politics
It is very strange to me that we are in a situation where many people want lower taxes, but these same people want to privatise income-generating public enterprises. Sure, you can argue that there are bad management incentives in public enterprise, but you don’t have to completely privatise the ownership to change the management incentives. Just privatise a part of it, then keep an equity stake to share in future profits.
I personally would like lower income taxes if governments could be funded via a share or profits in the nation’s most profitable enterprises.
What do you think?
Follow Fresh Economic Thinking on YouTube. Further exploring these issues is Matt Bruenig in this video.
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