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Forget business tax cuts, focus on electricity reform

While attempts to wangle a cut to business tax rates fail, there’s more to gain from repairing our energy regulation framework instead, write Bernard Keane and Glenn Dyer.

The failure of the Business Tax Working Group to recommend a revenue-neutral way to lower the corporate tax rate hasn’t surprised too many people: it was always going to be hard to identify a way to broaden the tax base sufficiently in a way that ensured a small number of losers and sufficient winners. But another reason why the working group threw the towel in is worth noting:

The economic benefits from a reduction in the company tax rate from the current rate are likely to be smaller than when the rate was much higher in the 1980s and 1990s, notwithstanding that capital may have become more mobile since then. The working group considers that a cut of two to three percentage points would be required to drive a significant investment response.”

That is, the benefits of a corporate tax cut, supposedly necessary because Australia has one of the highest corporate tax rates in the developed world, might have been overhyped.

A 2% cut in the corporate tax rate would, if not offset by base-broadening measures, cost $2-3 billion a year, according to the government’s figures given when the Coalition and the Greens blocked Labor’s tax cut. Treasury modelling for the working group suggests a 1% cut in company tax not offset by base-broadening would increase both GDP and real wages by 0.2% — but over an extended period, between seven and 20 years. That’s worth around $3 billion of GDP currently.

While the working group was throwing its hands up, Rod Sims of the Australian Competition and Consumer Commission was making a not unrelated point: that Australians, including business, were paying $3 billion too much for electricity courtesy of the flaws in the way we regulate electricity pricing.

While most of the media focus is on the consumer impacts of electricity price rises, business suffer much worse, because electricity is, for many businesses and especially manufacturers and retailers, a far higher component of their costs than electricity is in household budgets. But consumer costs are also significant because they feed into inflation, potentially limiting the RBA’s capacity to reduce interest rates, as we again saw in the September quarter CPI which revealed electricity prices rose 15% (and gas and other household fuels were up more than 11%).

Some of this was due to the carbon price, but economists suggested the carbon price contributed around 0.4% to the CPI in the quarter (remember Treasury estimated a 0.7% impact on the CPI from the tax), meaning that other cost rises, such as vegetables and fruit (more than 10%), played a big part, as well as the impact of power charges and costs.

Sims is only the latest in a succession of independent authorities to identify the huge cost of a flawed regulatory model for electricity pricing that allows power companies to use investment to game the system to gouge consumers. Ross Garnaut was the first prominent figure to call for a fundamental overhaul of electricity regulation when he updated his climate change reports in 2011 and identified market, government ownership of power companies and regulatory flaws as a key reason behind rising power bills.

The Australian Energy Regulator itself argued it lacked the power to prevent companies from overcharging. The Productivity Commissions’ draft report on electricity regulation last week showed how a more efficient, better regulated electricity network could “potentially save billions of dollars”. Now Sims has quantified how much.

Poor regulation of power, gas and water in this country and the seemingly cost-plus way of handing out price increases (it’s not as simple as that, but seems that way), with little attempt to wring offsetting benefits from the producers of power, gas or water, plus the distributors and retailers, is not helping improve productivity.

Better regulation of power company prices, particularly around investment and rates of return, and privatisation of state-owned suppliers and distributors would deliver as much or more for business than any corporate tax cut offset by base-broadening measures.

In fact the impact on productivity of poor regulation bears examining by the Productivity Commission. It should be an issue business hops on and prosecutes because higher power, gas and water costs are adding to the cost of doing business in this country (and hurting consumer finances and consumer spending and therefore retailers). Multi-factor productivity (that is labor productivity plus the business contributions of capital, innovation etc) is imprecise and much harder to measure than labour productivity which seems to be in an upturn (according to the March and June quarter national accounts) as employment growth slow and output is maintained.

Federal Treasury and others have already pointed out that multi-factor productivity growth in Australia is weak at best, partly due to inadequate management. To that you could add the adverse financial impact of regulatory failure of the sort we are seeing in electricity, but also in gas and water. But don’t tell the business media and their friends in the lobby groups.

If an incoming Coalition government is serious about reform it should prioritise the wholesale rewriting of the regulatory regime covering electricity, gas, water and other natural monopolies in this country (such as Sydney Airport) and the about-to-be sold off NSW government-owned ports ahead of another tax inquiry or even a financial services inquiry. The current regulatory situation for electricity in particular is clearly inadequate and starting to produce cost distortions on business and consumers that will retard growth across the economy, as well as impact employment and demand. It is a situation all governments and parties have had a hand in producing over the last two decades. It was the Keating government that began the establishment of the national electricity market and the Howard government that completed it.

It has been a hugely successful microeconomic reform but power companies have long since identified the weak spots in the framework established by the Commonwealth and the states for regulating prices, and gamed them. Both sides of politics in NSW and Queensland have failed to privatise power assets and used them as ATMs to prop up budgets. Like the disastrous telecommunications reforms of the Hawke government that were exacerbated by the Howard government’s sale of Telstra, there’s plenty of blame to go around in this.

There’s accordingly a pressing need for some policy leadership from Canberra to break out of the current regulatory impasse costing Australian businesses and consumers plenty.

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  • 1
    Jimmy
    Posted Thursday, 25 October 2012 at 1:49 pm | Permalink

    This is a very good article but once again let down by this tripe “If an incoming Coalition government is serious about reform it should prioritise the wholesale rewriting of the regulatory regime covering electricity, gas, water and other natural monopolies in this country” Why is it constantly assumed that the coalition has won the next election? It is this sort of reporting that has seriously reduced the quality of political journalism.

    To me the govt now has significant information to reform in the electricity sector is required and should develop a policy over the next 6-9 motnhs to take to the election (qassuming it couldn’t get it through before then.)

  • 2
    Jimmy
    Posted Thursday, 25 October 2012 at 1:50 pm | Permalink

    This is a very good article but once again let down by this tripe “If an incoming Coal ition government is serious about reform it should prioritise the wholesale rewriting of the regulatory regime covering electricity, gas, water and other natural monopol ies in this country” Why is it constantly assumed that the coalition has won the next election? It is this sort of reporting that has seriously reduced the quality of political journalism.

    To me the govt now has significant information to reform in the electricity sector is required and should develop a policy over the next 6-9 motnhs to take to the election (qassuming it couldn’t get it through before then.)

  • 3
    paddy
    Posted Thursday, 25 October 2012 at 1:59 pm | Permalink

    I’m with Jimmy on this one. The so called “inevitability” of a coalition victory at the next election seems to be getting less likely by the week.
    Plus, the chances of that bunch of time serving hacks who make up the opp front bench, actually managing to institute meaningful reform….. Fanciful nonsense.

  • 4
    Jimmy
    Posted Thursday, 25 October 2012 at 2:03 pm | Permalink

    Paddy - “Plus, the chances of that bunch of time serving hacks who make up the opp front bench, actually managing to institute meaningful reform….. Fanciful nonsense.” Recent history would be with you on that Paddy, what reforms did the Howard got achieve, the GST and what in 11 years? The Gillard/Rudd and the Keating/Hawke govt achieved much more.

  • 5
    Edward James
    Posted Thursday, 25 October 2012 at 2:36 pm | Permalink

    Government was once our energy supplier, at a break even arrangement with taxpayers. We put them in charge/let them take control of our resources like coal water and gas. They in the greed not wisdom privatised what we the peoples had put in place. They did what they are still doing. Selling our country and its resources out from under us. all the time borrowing in our names amounts of money we can never hope to pay back. almost everything which happens in the way of business has interest on borrowings tied into it even our sovereign activities are being financed with borrowings. I am dead against this abuse of the peoples trust! Edward James

  • 6
    Jimmy
    Posted Thursday, 25 October 2012 at 2:43 pm | Permalink

    Edward James - Nice rant but what is your point? Should we outlaw borrowings? Should energy companies wholly owned state assets (despite all evidence that the reverse is true)?

  • 7
    Edward James
    Posted Thursday, 25 October 2012 at 2:55 pm | Permalink

    I thought my rant was clear enough Jimmy We the people once owned coal and energy infrastructure. Energy was supplied to us on a break even basis on infrastructure whic taxpayers paid to put in place. Both Labor and Liberal Coalition put in place with their regulation of the Electricity Supply Act in March 1999 the legal stepping stones to assist them in privatising the supply of our energy. Now the rise in cost to consumers is distanced from government. Any talk of government controlling the rising cost is as mythological as government controlling the price of our petrol. why wen we turned up here in Australia and took over from those who were already here, would responsible government sell off our so called sovereign resources? Edward James

  • 8
    Edward James
    Posted Thursday, 25 October 2012 at 3:03 pm | Permalink

    While I would not go so far as to outlaw Jimmy I do question the Federal and State government borrowing against the peoples capacity to keep up with the interest rates on already OTT borrowings made against our perceived capacity to pay. I believe the interest attracted by almost everything we do will be our eventual fiscal doom. i certainly believe peoples have exchanged the iron chains of slavery around our necks, for an almost invisible chain of debt, draped around our shoulders by those very people whom we have given our votes to in trust. Edward James

  • 9
    MJPC
    Posted Thursday, 25 October 2012 at 3:11 pm | Permalink

    I am with Jimmy and Paddy on this. Why would an incoming coalition government (which is also a non possibility) address this inequity when they are quite prepared to lie at every turn in blaming the carbon tax for any price rises in energy.
    As for the NSW Government and Port Botany, we already have reports that if the sale progresses the price of fuel stored on site will escalate for the consumer.
    Of course we have trite promises from the O’Farrell government legislation will be in place to stop gouging but facts stand that when public utilities are sold to their mates, it is usually at too high a price then the ever suffering public pay the cost with the pollies bleating “how horrible” or “we can’t do anything” (i.e Sydney Airport costs), yet they have ensured a monopoly has been achieved.
    The current Feds need to act on the electricity now.

  • 10
    Jimmy
    Posted Thursday, 25 October 2012 at 3:49 pm | Permalink

    Edward James - NSW, Qld and WA still have state owned energy assets yet their prices are rising more than Victoria’s privately owned industry so govt ownership clearly isn’t the answer.
    And if you expect these govt to simply not make a profit on these energy assets (as you attest once happenned) would you instead pay higher taxes to cover the shortfall in revenue or make do with fewer services?

    And you post dealing with borrowings is just nonsensical ramblings.

  • 11
    Sanjay
    Posted Thursday, 25 October 2012 at 5:12 pm | Permalink

    With no increase in generating output where was the network over streached. It seems we have a lot of redundent cables waiting for new power stations to be built.

  • 12
    taylormade
    Posted Thursday, 25 October 2012 at 6:09 pm | Permalink

    Dont let Gillard and Swan anywhere near the repair job, the power co’s will see them coming a mile away. Let Ferguson, Crean and Combet handle it, we will all be better off that way.

  • 13
    Eponymous
    Posted Friday, 26 October 2012 at 8:24 am | Permalink

    This piece, the Productivity Commission report and virtually every other piece on electricity in the NEM grossly simplify the realities of making electricity go through wires.

    The key point they all get stuck on is the “network which is sized to only accommodate about 20 hours a year”. I would wager that is the way it has always been; demand changes a lot overnight and seasonally, so sure, it will only be at its maximum for a little while. Maybe we should rebuild 4 lanes of the Harbor Bridge every day?

    And yes, there are perverse incentives for network owners to over-invest, but to suggest that billions could be saved is ambitious at best. Yes, they spend billions upgrading the network, but most of that is necessary to supply power for the increasing network peaks as everyone buys AB and big teles that our glorious prosperity brings.

    So sure, reign in some of the investment rules, and I reckon it could save 100m on the east coast over 5 years. The reason network companies are spending money is consumers. We either reduce maximum demand or we pay for network upgrades. Either accept a smart meter, insulate your house or move to time-of-use pricing, or just shut up.

  • 14
    Person Ordinary
    Posted Friday, 26 October 2012 at 4:44 pm | Permalink

    … agree with all comments so far. The real question though is what happens next.

    Will our illustrious journalists do more than simply demand the government “do something?” They need to put more meat on the bones of the story, and show us more detail about the over-investment games. Maybe a map, if it can be explained geographically, or a breakdown of expenditure by the power companies and comparison with those in similar markets. Come on Crikey, it is up to you to do more on our behalf …

  • 15
    Mark Skinner
    Posted Saturday, 27 October 2012 at 12:00 pm | Permalink

    I have to agree with eponymous.

    Since the power system capacities are linked to the maximum daily demand, infrastructure costs are highly connected to the need to satisfy that single day.

    Of course, one could address this by completely rewriting the regulations, a massive and complex task one would think. Such regulation, if directed toward minimising investment, also leads to the management philosophy of ‘you pretend to pay us, and we’ll pretend to provide you with the reliability’. Major infrastructure failures in Auckland and Darwin come to mind.

    The alternative to complex rebuilds of the legislative and regulatory framework would be to introduce demand management to reduce that maximum daily demand to achieve the same result. So, if one wishes to reduce costs, why not simply require the power companies to introduce and enforce demand management? Surely that is simpler than trying to rewrite the whole regulatory framework?

    Why do economists try to overcomplicate something which is fairly blindingly obvious. You want less infrastructure built, so reduce demand. If people don’t want to reduce demand, then either build the infrastructure, or accept a lower level of reliability. It is not rocket science, and much simpler than reams of obscure regulation…the more of which you have, the easier it becomes to game.

    As for privatisation. Hm, well if you want to sell a utility to the private sector, do you really want to make that utility less attractive by either an uncertain regulatory environment (which is what you will get if you huff and puff about rewriting regulations) or by restricting its profitability in some way? If you do, then are you going to get the price that will make the whole asset transfer worth while?

    When Telstra was privatised, it was done in such a way as to lock in a monopoly and a regulatory black hole, that has only recently (and very expensively) been resolved. That maximised the price the Government got for it, but was hardly an optimal outcome. It seems to me that the electricity privatisations to date have also suffered from this. So, for privatisation to go ahead, perhaps the new regulatory environment, or preferably the far simpler requirement for power companies to undertake demand management, needs to be in place first, and that lower prices for the assets accepted. After all, who is going to invest in such assets unless a commercial return and a certain regulatory environment is available?

    It seems to me that for a number of years, electricity utilities had neglected their infrastructure, effectively mining their assets, until some actual disasters (Auckland and Darwin) and some unreported near disasters shocked them (and the regulators) into the need for urgent investment in infrastructure. Of course this meant an expenditure pattern of low investment for maybe ten years (which became to be seen as the norm) followed by a panicked high level of catch up investment.

    Faced with this seemingly high rate of increase in investment, both regulators and politicians have had a problem. The solution to a political problem is to be seen to be doing something (and rewriting regulations is a great one), and finding a simplistic scapegoat (oh the power companies are gold plating their infrastructure and gaming the system).

  • 16
    Harris Evan
    Posted Monday, 29 October 2012 at 11:49 pm | Permalink

    It seems to be assumed that energy consumption will rise along with population expansion and growth in living standards. There is an argument that cheap energy discourages energy thrift, so it might fix itself. In fact energy is already a highly regulated and politically primed public service, as necessary now as antibiotics or the banking system. The question is, what is REALLY driving energy costs, and what is really driving up demand. Of the many unintended consequences of a growth society,the belief that growth is good restrains the moderation of population and the rational distribution of equity through the whole society. I think the privatisation of community services (like energy) will work, provided guarantees are in place to keep the consumer from the destructive forces inherent in extracting a profit to make the business work. The planet becomes uninhabitable not by the depletion of resources but by the denial of justice to those who can’t afford it.

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