Gerard Jackson
BrookesNews.Com
Thursday 28 August 2003

It has been many years since our commentariat managed to persuade me that they are not qualified to write on economics. By qualified I don't mean a PhD in the subject or even a modest B.A., just evidence that they have done some serious study. Alas, I am invariable disappointed.

Cathy Sherry, a lawyer and freelance writer, is no exception. Although the first part of her article (Snobbery, not stamp duty, causing 'wage slavery', The Age 24/08) provided an elementary review of supply and demand in action, the article itself was just an apologia for the right of governments to loot house buyers. Needless to say, she also fell prey to common economic fallacies

According to Sherry "Low interest rates put more money in purchasers' pockets…." This statement in itself should be enough to make any person with a reasonable knowledge of economics groan. When interest rates fall in a free market it is because the social rate of time preference has fallen, meaning that people have chosen to curb current consumption in favour of greater future consumption. In ordinary parlance, they have decided to save more.

The initial effect is to increase capitalisation and lower the discount rate on wage rates so that net pay rises, particularly in the higher stages of production. (Professor Earl Rolph adopted the erroneous Knightian view of discounting factor incomes. Readings in the Theory of Income Distribution). Total money incomes do not change at this point. What happens is that increased savings lengthen the production structure, which then raises productivity and so increases output by lowering production costs. It is this process that raises real incomes.

However, when the Reserve accelerates monetary growth through the banking system credit expansion takes place. This expansionary policy forces down the rate of interest and raises nominal incomes. One should not have to be a trained economist to see that in this case credit expansion is the force behind any general increase in money incomes. Furthermore, it is this monetary policy that triggered our housing boom and continues to "add fuel to the fire." (See The nature of interest rates and why it's dangerous to manipulate them).

Sherry goes on to take a swipe at home buyers who object to politicians ripping them off through the stamp duty. Now Sherry thinks stamp duty is a jolly good thing because it's progressive — so is cancer, but I wouldn't recommend it to anyone — and only those who buy houses pay it.

What's more, stamp duty has the advantage of reducing the demand for houses. (Have you noticed how the lefties' answer to scarcity in the private sector is to reduce demand rather than increase supply?) Quoting Blair Warman, an economist, Sherry argued that "lowering stamp duty will just take money from the Government, put it in vendors' pockets and add fuel to the fire."

It seems to have escaped Sherry and Warman's combined intelligence that it is the government who is taking money from vendors. To argue otherwise, as they do, is patently ludicrous. In addition, they overlooked the obvious fact that reducing vendors' purchasing power also reduces their demand for white goods, furnishings, etc.

For the sake of simplicity let's assume the housing market is in equilibrium. Anyone acquainted with basic economics knows that the price of any good, including housing, will be determined at the point where supply and demand intersect. Now along comes the government (a group of politicians) who slaps a sales tax, called stamp duty, on houses. This policy shifts the supply curve to the left, driving up house prices by reducing the available stock.

It's important to understand that the tax is being shifted backwards and not forwards, thereby reducing the demand for factors of production. (This is what happened when the government first implemented the GST. The conventional view has it that one can calculate how the tax is apportioned between producers and consumers. This approach is completely fallacious. Unfortunately it would take a much longer article to explain why).

Therefore cutting the stamp duty will shift the supply curve back to the right which increases output and so drives down prices. This makes a mockery of Alan Wood's assertion that cuts in stamp duty will be capitalised into higher house prices (Housing inquiry free to question, The Australian 5/8/03).

What Wood overlooked is that where demand remains unchanged, the increased supply of housing will push down prices. In the present situation, credit expansion will continue to shift the demand curve to the right and pull up house prices, even as the quantity of housing increases. But one should stress that in this instance it would be the rise in demand that raised houses prices, not the capitalisation process.

(As an aside, unless the central bank halts a housing boom a situation could emerge where the level of spending continues to grow while the amount of housing offered for sale shrinks. This would signal that the end of the boom is approaching.)

The shifting of the supply and demand curves to the right is an interesting point because Sherry appears to argue that cutting the stamp duty will reduce government revenue. But our analysis shows that more housing will be supplied, suggesting that government revenue could actually rise.

Sneering at those who want to cut stamp duty, she asked the rhetorical question: "...where do they think the money comes from" for education and spending. Well, Sherry, it actually comes from economic growth. (Strictly speaking, we are talking about resources. If it were a simple case of money the government could print all that it needed). Continuing with her elongated sneer, she also justified stamp duty on the grounds that it "is only paid by those wealthy enough to buy property."

Note the loaded phrase "wealthy enough." Obviously, according to the self-righteous Sherry, those who manage to buy a house, no matter how modest, have no right to object to tax policies she supports, regardless of how much damage they do.

If Sherry were genuinely concerned about the less well off she would direct her considerable wrath at policies that deliberately price people out of work rather than spend her time slagging people who are struggling to give their families a decent home

Gerard Jackson is Brookes' Economics Editor