There are many reasons why the proposed flood levy is a bad idea, including the following:

  • It’ll reduce the government’s popularity even further;
  • The public will reduce voluntary donations to flood victims;
  • Consumer spending will drop, placing further pressure on retailers;
  • There’s a possibility the temporary levy will become permanent;

And so on. These objections to the new tax have already been widely discussed, so there’s little point in explaining them further here. One big financial problem with this and any other sort of levy, however, relates to the relative cost of borrowing between the government and households. Put simply, the 0.5% to 1.0% flood tax is not just unpopular, it’s also economically inefficient. Here’s why.

Most of the households at which the tax is aimed, i.e. those earning $50,000 per annum and more, are likely also to be paying off a home mortgage. At the moment, the annual variable interest rate for such loans is probably between 7.5% and 8%, with another 50 basis points of rate rises likely to arrive before the calendar year is done.

Because households can pay down a variable home loan (overwhelmingly the most common choice for Australian borrowers) at any rate they like above the agreed monthly minimum, the interest rate they’re charged is effectively their cost of funds for all expenditures. That is, if they choose to forgo, say, $1000 of discretionary expenditure, then they save 7.5% to 8% of this in annual interest.

Precisely because of its ability to tax citizens with impunity, the federal government’s borrowing costs are considerably lower than those pertaining to the average household. Right now, for example, Commonwealth 10-year bonds are trading at a yield of 5.51% per annum.

This means that if he wants to, Treasurer Wayne Swan can borrow money for 10 years (the approximate life of the average home loan) at a rate 2.5% to 3% less than us poor households — yet instead of taking advantage of this glaringly obvious interest rate differential, the government’s moderate financial burden from the floods is being foisted on to the public.

What Swan is doing here is a bit like a consumer who has a credit card he or she never pays off, plus a housing loan with a redraw facility. As the credit card probably costs between 12% and 20% per annum, the consumer should avoid using it in favour of the much cheaper form of finance also available (i.e. the housing loan).

Admittedly, there are people out there who do make silly decisions with their personal finances, and thereby pay a lot more in interest than they should. It’s sad, however, that such financial idiocy should make its way into the federal Treasurer’s office.

In a nutshell, while the government can borrow so much more cheaply than the households it’s supposed to assist, there is no good reason why the flood costs should be funded at personal home mortgage rate — which is exactly what, for most people, the proposed levy represents.

Peter Fray

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Peter Fray
Editor-in-chief of Crikey