An interesting video from Dan Mitchell, from the Cato Institute, explaining the Rahn Curve and the curse of big government:

Australian Government spending:

The Australian Government spending as a proportion of GDP as of 2007-2008 was 24 percent (source). In the above video, Dan references a number of studies that show that the optimum government spending to GDP ratio should be between 15 to 25 percent. Although keep in mind this is only the federal level of spending. If we were to include local, state and federal spending, then total government spending would be 34.2 percent of GDP (source). This would put us on downward slope of the Rahn curve.

In Australia, we operate with three tiers of government: local, state and federal (you could argue that there is a fourth: the UN and our obligation to its treaties). Government expenditure is most effective when the geographical spend is concentrated in the area where taxes are raised. For example, I can see directly that my local council rates go towards local roads and my garbage collection. By having many small, local and regional government councils, innovative service delivery and taxation regimes can flourish to encourage residents and business to be established. If I do not like a particular council, I have greater access to the elected officials to air my grievances. If I feel strongly enough I can move to another council region (which is much easier than moving state or to another country). This can breed a healthy competition among councils to give the best “bang” for its rate payers buck.

So it is refreshing to note that, in a recent survey by Griffith University, more people are favouring localised and regional governments as opposed to state governments:

The Griffith University report found rising support for abolishing state governments, from 30 per cent to 39 per cent between its May 2008 and March 2010 Newspoll surveys. But it also found increasing support for abolishing federal and local governments. The federal government’s rating as the most effective tier of government has dropped from 50 per cent to 44 per cent, even after Rudd helped save Australia from the global recession and neo-liberalism. Most of this decline was captured in an increase, from 20 per cent to 27 per cent, in support for local councils as our most effective level of government.

But most striking is that 42 per cent of Australians now favour creating regional governments, up from 32 per cent less than two years ago. Adding the 9.3 per cent who favour “more states” suggests that one in two Australians favours shifting power below the state government tier.

…more than one in four Australians now judges its local council to be the most effective tier of government, compared to the less than one-in-six who prefers state governments.

Don’t be put off by the length of this video. The video is from the Mises Institute, and reviews Henry Hazlitt’s “Economics in One Lesson” by asking Austrian economists to give their synopsis of each chapter in the book. If you want an excellent introduction into economics, then put this on in the background while you work.

Contents:

1. Walter Block – The Lesson
2. Thomas DiLorenzo – The Broken Window @ 15:58
3. Jeffrey Herbener – Public Works Means Taxes @ 24:28
4. Tom Woods – Credit Diverts Production @ 41:56
5. Robert Murphy – The Curse of Machinery @ 56:41
6. Walter Block – Disbanding Troops and Bureaucrats @ 1:12:21
7. Mark Thornton – Who’s Protected By Tariffs? @ 1:29:35
8. Peter Klein – “Parity” Prices @ 1:47:06
9. Guido Hulsmann – How The Price System Works @ 2:09:13
10. George Reisman – Minimum Wage Laws @ 2:36:41
11. Joseph Salerno – The Function of Profits @ 2:52:45
12. Roger Garrison – The Assault on Saving @ 3:13:18

When I did my economics unit at University I learnt that if you tax goods at a rate higher than other goods, you will discourage consumption of that good. This is the basis of all “Sin” taxes on alcohol and cigarettes. A corollary is that investment in producing that good will similarly be discouraged.

This elementary fact is lost on the Federal Government’s treasury chief, Ken Henry:

The review reportedly tabled by Australia’s Treasury chief, Ken Henry, and leaked to media last week, recommends scrapping individual Australian state royalty taxes on mining projects in favour of a 40% uniform national resource tax.

For the record, the corporate tax rate is 30% of profits. Thus Ken Henry is proposing a 33% tax rate hike (from 30% to 40%)  just “because you are a miner.” Apparently this is to help fund the aging population.

Here are just a few unintended consequences:

1. Small to medium sized businesses in the mining sector now find it harder to attract capital, as investors will now be attracted to other companies with a lower tax rate. In other words, the return on investment for miners is now 33% lower.
2. Shareholders in mining companies now get 33% less in dividends, meaning less money to re-invest, save or spend, leading to reduced economic output.
3. Replacing the state royalty taxes, now means that states will find it harder to compete for mining businesses to set up in their states. Competition between states reduces royalty tax rates in the long term.
4. Mining exploration is discouraged, thus leading to lower rates of mining activity, thus leading to lower economic output (including lower exports).
5. Superannuation returns from funds invested in mining companies will be lower, thus actually adding to the problem of funding the aging population that it is purportedly trying to solve!
6. Mining companies will have greater incentive to explore overseas and not in Australia.
7. Discouraging mining activity may actually reduce tax receipts due to the Laffer curve effect.
8. (UPDATE) Companies delay investment decisions due to proposed resource tax, thus dampening economic activity.

UPDATE: Looks like it’s going to happen.

UPDATE: More from Michael Stutchbury from The Australian.

I stumbled across an interesting analysis of a new technological process, horizontal drilling and extraction of shale natural gas. Read the whole thing here but here is the key chart comparing horizontal vs vertical wells:

Comparative production from a vertical and horizontal natural gas well (Chris McGill).

Production Volume

One thing that did strike me is that the horizontal peak production is well above the vertical well but has a shorter life span. Horizontal wells do have significant technical challenges (as seen in the article), but perhaps we can analyse the above chart to give us an idea of the benefits of horizontal drilling. Now to do this is a little tricky, as I do not have the original chart. However, using Photoshop, I was able to extract the area of the chart and the scale to get us total volume (note these are approximations only, but it gives us a “back of the envelope” view):

• Vertical Well (Yellow): 3547 MMFC
• Horizontal Well (Orange): 6097 MMFC
• Horizontal to Vertical Well total production gain: +72%

Judging from the chart the horizontal well extracts and extra 72% more oil in 10 months versus 100 months for vertical wells.

Production Value

Now to estimate the total value of the well let’s assume the price of natural gas is stable (at Henry Hub) at $8.00 per MCF:

• Total value of the horizontal well is  6097*1000*$8.00 = $48,776,000
• Total value of the vertical well is 3547*1000*$8.00 = $28,376,000

Time Value of Money

This is where we get to use some basic financial models to determine the value of horizontal wells compared to vertical wells. The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time. As an example, with an interest rate of 5% per annum, 100 dollars received today is equivalent of receiving 105 dollars in a year’s time.

Note that the horizontal well lifetime is 10 months compared to the vertical well lifetime of 100 months. Thus to be fair we need to compare the value of the horizontal well and the vertical well after 100 months. This is where the Time Value of Money comes in. Let’s pretend we bank the $48,776,000 that the horizontal well extracts, thus after 100 months (assuming 5% interest rates):

• Total value of horizontal well at 100 months: $70,913,392
• Total value of vertical well at 100 months: $28,376,000
• Horizontal to Vertical well gain: +150%

Extraction Costs

I do not know, in detail, the relative difference in extraction costs for these two methods. However, we now have the Horizontal to Vertical Well gain to use in our decision making. If the Horizontal to Vertical well cost is less than Horizontal to Vertical Well gain (+150% in our example), then it becomes economical to use the horizontal well method.

UPDATE: here is some commentary from The Oil Drum on this article regarding the discount rates:

The Former Soviet Republic of Georgia is debating a law to enshrine economic liberty to its citizens and placing constitutional limits to government spending and taxation. This is interesting because we always hear politicians bleat about restraining spending but invariably once they are in a position of power, renege on their promises.  By enshrining it in a constitutional form means that it is harder to back away from (although not impossible, if parliamentarians/citizens vote for change).  From the Government of Georgia’s press release of the draft :

Fiscal Responsibility

1. Budget expenditure capped at 30% of GDP (FY 2012)
2. Budget deficit capped at 3% of GDP (FY 2012)
3. Public debt capped at 60% of GDP (FY 2012)
4. Extrabudgetary funds are limited
5. Budget earmarks are limited

1. Budget expenditure capped at 30% of GDP (FY 2012): 30% budget expenditure cap is a little high (the US government spending is currently at 40% of GDP!). There is contention as to the optimum level of government expenditure, but below is a chart of reference by a Heritage Foundation report, that shows the optimum level is between 18 and 20% of GDP:

However, having a cap means that it can’t get any worse.

2. Budget deficit capped at 3% of GDP (FY 2012): deficits generally occur when there is a downturn in the economy. Having a cap of 3% of GDP means that politicians will be not be tempted to “bailout” and provide special deals to inefficient industries.

3. Public debt capped at 60% of GDP (FY 2012): This seems high, but Georgia is a newly democratised, fast growing economy in an military unstable region (eg. Russia’s recent invasion). It is understandable that public debt may be higher than OECD countries at this time.

4. Extrabudgetary funds are limited and 5. Budget earmarks are limited: Placing spending limits on special deals for a politicians constituents is a positive measure.

Empowering Citizens by Ensuring Choice in Social Programs
The Liberty Act advances the long-standing policy of delivering targeted social assistance by funding citizens through vouchers and cash benefits (healthcare coverage, education, poverty benefits, etc) rather than funding directly the institutions engaged in the provision of healthcare, education and other services. It provides for the freedom of choice of the beneficiaries to select the service providers

This is an good way to execute government spending programs, but a better way would be to let the free market provide these services. However, vouchers and tax/cash benefits is the least bad way of government providing such services. Citizens having the power to pick and choose their service provider, should mean that service providers must compete for their survival.

Returning the Power to Tax to the People
No new taxes or increase in the tax rates may be imposed other than following an affirmative vote in a nationwide referendum

This is an excellent idea. The public generally hate paying more tax. Politicians running on a campaign of increased taxes, has a very short lived political career.

Will be interesting to monitor its passage into law.

(via Cato)