Governments so often get revenue and spending measures wrong.
There were another couple of examples in the past week. The Medicare safety net was a classic.
The net was set at $300 for low-income earners and $700 for others. Beyond that the Government would pay 80 cents in the dollar of all medical expenses.
It was to cost $440 million. But the forward estimates quickly blew to $1 billion. How could a government armed with the best financial advice get it so wrong?
The fundamental problem seems to be that governments assume that existing behaviour will continue after a new financial measure is introduced. It is rarely the case, though.
People enjoy government hand-outs – so they will change their behaviour to take advantage of them. People do not like taxation – so they will change their behaviour to avoid it.
If people had not changed their behaviour, the new safety net would have cost $440 million. But they did not. Doctors rubbed their hands in glee. If the Government was picking up the tab, why not charge the patient more?
And patients, meanwhile, thought that if the Government was picking up the tab, why not go for that elective surgery right now.
The new policy resulted in a higher demand for medical services and those services costing more.
Scientists could tell the economists a thing or two. They know that the mere act of observing something can change its behaviour.
Another example is speculation that the Government will restrict Medicare rebates for IVF patients to three courses of treatment a year — in theory, saving money because at present some women have half a dozen treatments a year.
Wrong. Women will change their conduct. They will limit themselves to three treatments in a year, all right. But that will lessen the chance of pregnancy, so they will have another three treatments the following year, and so on. With only three treatments a year, the chance of pregnancy is lessened, so more women will have more treatments under the new regime. There will be no saving, just a lot of inconvenience and failure.
The NSW Government’s vendor stamp duty was another classic. It imposed a 2.25 per cent stamp duty on people selling houses (in addition to the duty on people buying houses). Based on current sales the Government thought it would get $690 million a year.
Wrong. Investors deserted the NSW property market. The Government did not achieve its target. Moreover, because activity slowed as a result of the vendor tax, the Government missed out on a large amount of buyer stamp duty as well.
Access Economics estimated earlier this month that the new tax, far from raising money, was costing the NSW Government $280 million a year.
Talk about shooting yourself in the foot.
In the 1960s, the economic dogma was that the tax system should to be “progressive”, rather than “flat”. As income rose taxpayers paid a higher percentage of each additional dollar in tax.
Until the mid-1980s the top marginal rate in Australia was 66 per cent. In Britain in 1979 it was 83 percent. The theory was that the top income earners would pay a higher proportion of the total tax take because they could afford it.
The theory was twaddle. As the marginal rates rose, people responded accordingly. If you are paying 83 per cent or even 66 per cent in tax, there is a high incentive to avoid, or even evade, the tax – by moving it off shore, into trusts and companies, into cash, or whatever.
The tax rates had the opposite effect of what was intended. In 1979 in Britain, the top 10 per cent of earners paid just 35 per cent of total revenue. Margaret Thatcher slashed the 83 per cent rate to 40 per cent in 1979. And by 1990 the top 10 per cent of earners were paying 42 per cent of revenue.
In the US, after President Ronald Regan slashed tax rates, the bottom earners paid a lower proportion of total revenue and the top 5 per cent taxpayers lifted their contribution from 35 per cent to 39 per cent.
The GST was another example of a government not understanding that people would change their conduct with the new the tax. The result has been that GST revenues have exploded.
Because businesses can claim back the GST on their inputs, they insist on proper paperwork from suppliers – thus snaring a lot of people who used to be outside the system.
At the time, the Government had little idea what a windfall the GST would be.
With welfare, the Government thought it would save money with work for the dole. But the result was a blow-out in disability payments as people responded to the strict work-seeking tests by claiming disability.
Even outside finance measures, governments often pass laws that have the opposite effect of that intended. Locally, we have high dump fees to encourage recycling, but they encourage roadside dumping. We have compulsory energy-efficiency ratings that burn more greenhouse gases in the making than saving in environmental awareness. We have an anti-gazumping law that indeed encourages gazumping (that is a column in itself).
The basic point is that when governments legislate, people behave differently. But time and again governments assume people will behave in the same way. And they wonder why they get it so wrong and have to go back on election promises.