This morning’s Age has the first of the Budget polls on what the government should do with one river that certainly isn’t drying up – the river of taxpayers’ cash flowing into Treasury. For some reason, unlike previous years, they have not asked about a choice between more services or less tax, but simply asked ‘Do you support or oppose cuts to income tax as part of this year’s federal budget?’
Two-thirds of the poll’s respondents think that income tax cuts should be part of this year’s Budget, and a little under a quarter oppose cuts. Taken in isolation from the missing services alternative, that roughly transposes the figures from last year, in which 29% wanted tax cuts and 68% more spending on services and infrastructure.
Though it would be interesting to see a repeat of the tax cuts versus services question, the insertion of the phrase ‘as part of’ into the question does highlight that the question in earlier years at least partly created a trade-off that did not need to be made – the government could (and did) cut tax rates while also increasing spending. Indeed, as the tax revenue statistics released earlier in the month showed despite the cuts to tax rates for 2005-6 tax revenues increased by more than 5% per person on the previous year.
Perhaps also voters are wising up to the realistic alternatives available. If we don’t get tax cuts, where will the money go? As the AFR reports this morning, the government is sitting on more than $2 billion in discretionary programs even before it dips into the surplus to finance its election promises. If you don’t live in a marginal seat, you’d be mad to prefer this pork barrelling to tax cuts. Or if the money isn’t being spent on marginal seats, it will be stashed away in the Future Fund to provide a comfortable retirement for public servants. Again, I can’t think of a strong reason to prefer that to tax cuts now. I’m in the 24% of voters who ‘strongly support’ tax cuts.
Andrew Norton 
You’re a good man, Andrew! I’m just a little concerned this time that the tax cuts will be to those undeserving lower and middle income earners who already pay little tax. Alternatively, they could fund an increase in compulsory super to avoid the accusation they are fueling inflation and interest rate increases. But I guess it’s all better than more spending… Surely real tax reform can’t be on the agenda?
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I would have thought any cut in income tax rates without any cut in spending will merely exacerbate the structural deterioration of the budget that has occurred over time
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“I’m just a little concerned this time that the tax cuts will be to those undeserving lower and middle income earners who already pay little tax.”
While I agree that it is a little difficult to give large tax cuts to people who pay little tax (something that consistently seems to elude most leftish commentators), people who favour a reduction in high effective marginal tax cuts for people on welfare should be supporting a significant increase in the tax threshold or some cut to the lower marginal rates. It would also be a good move to lift the income threshold at which the 30 per cent rate cuts in as that is a big contributor to high EMTRs for many people.
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That should be high effective marginal tax rates, of course
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I would rather have infrastructure than a ‘milkshake’ tax cut. There’s been talk of moving more food production to the North where there’s water – presumably that would involve huge infrastructure costs for transport etc. Then there’s renewable energy and all the other things we should do but only talk about.
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I agree, backroom girl, that’s a good suggestion. I was just being a bit facetious. I would like to abolish family tax benefits altogether, but some might consider that unfair.
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The AFR also reported two days ago that economists are urging the government to forget tax cuts for fear of increasing inflationary pressures and interest rates. According to the article, the economy is ‘close to capacity’. Could someone explain this to someone who knows almost nothing about economics, and how we could, from a “classical liberal” perspective, get around it?
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Well, these days the EMTRs associated with family tax benefits are not too bad, since the Government has done such a “good” job of liberalising the income test and in the process extending their reach way up the income scale. The worst EMTRs are experienced by people who are receiving income support, especially unemployment benefits and related payments. And the simplest way to reduce those is to cut taxes at the bottom.
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Those mostly unnamed economists in the AFR were suggesting that tax cuts would stimulate demand leading to inflation. That is a silly argument. There is no reason to believe that private spending would cause inflation but public spending won’t. Indeed and Ken Henry argued all government spending now shifts resources from high value use to low(er) value use. He thought this was due to the economy being at full employment, but I suspect this happens all the time.
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Leon – The theory here is that if taxes are cut there will be more money floating around the economy, but with many parts of the economy already at or near productive capacity the result will not be more production but higher prices, as more money chases the same amount of goods and services.
As Sinclair noted, it is hard to argue that tax cuts would be more inflationary than spending. Indeed, they would probaly be less inflationary than some forms of spending (eg Russell’s proposal for more infrastructure) because tax cuts are saved as well as spent.
The relevant comparison is with the government saving the money eg the Future Fund. I am no expert on this issue, but my impression is that many economists think that a few billion dollars in tax cuts would not have much impact on inflationary pressure.
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BG, then could it be cheaper (in a budgetary sense) to do the same ‘good’ job with the dole as for family tax benefits, instead of cutting the lower tax rates for all taxpayers?
As for tax cuts and inflation, I’m not sure what the precise trade off is. But if tax cuts are given (reducing public sector saving)and interest rates increase to stave off inflation, presumably this will reduce consumption/increase private saving. I would rather private taxpayers choose to save than government save our taxes for us somewhere else.
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Russell,
The Ord River Dam Project already has all the infrastructure needed: pipes, roads etc. The problems working against the expansion of the irrigated area are largely political.
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Jacques – I was thinking of Queensland – isn’t there rain up there somewhere ??
Hasn’t anyone anything good to say about a bit of inflation? How do you all imagine people paid off their mortgages over the last 30 years?
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“There’s been talk of moving more food production to the North where there’s water – presumably that would involve huge infrastructure costs for transport etc.”
Its amazing how few ideas most Australians have. If you are going to spend billions, surely there are better things than yet more subsidies for food production/destroying the environment.
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Leon,
The ‘tax cuts cause inflation and thus lead to higher interest rates’ furphy gets wheeled out this time every year, never with any supporting evidence.
Stephen Kirchner’s ‘Institutional Economics’ website contained a few pieces on this topic last year. Andrew has a link to his site, you may want to look through his archives for last May.
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So you don’t think it could be a good thing to encourage population centres in the North (where there’s water) to grow, rather than just letting our southern urban centres keep ever-expanding into drying environments?
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In the AFR on 22 February I wrote,
Further on I had this point (emphasis added)
Stephen Kirchner often makes very similar arguments.
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“So you don’t think it could be a good thing to encourage population centres in the North (where there’s water) to grow”
No, not for an insignificant number of people to get subsidized to destroy the environment/grow subsidized food, complain that there are not enough doctors/teachers in obscurity etc. . Why not move to the EU to do it instead? It rains in lots of countries there, the soil is better, and the subsidies already exist. Or is that those subsidies are somehow worse than those you are suggesting?
Also, if you want to distribute the population, stick a proper fast train between Brisbane->Goldcoast->Newcastle->Sydney->Wollongong->Melbourne->Geelong. If you want a new city, move Canberra to the coast, and people might actually want to live there.
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Conrad – what do you think we’re doing to the environment where we are – as we extract the last bit of groundwater, emptying all lakes and wetlands in the process, and with plans for even worse?
High speed railways seem a good idea – we’ll have one from Perth to Albany too please – but do you think private enterprise will build them?
(I also like the idea of building a sort of pergola over train lines, covered with PV panels – a sola pergola – stretching for miles and miles through the cities, after all the government already owns the land, it’s cleared, fenced …. see, lots of ideas!
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Russell, I think the average city dweller does vastly less envirornmental damage than the average commercial farmer.
As for fast trains — I don’t know if private enterprise would build them (although you can certainly make a profit with them, as TGV does in France — I also noticed they were thinking of sticking a line down some of the West Coast of the US recently, so that would be worthwhile looking at too). I can imagine any deal for this type of infrastructure is going to be vastly complex since it would involve government land etc. .
There was a private company that thought that wasting money on the Adelaide to no-where line was a good idea, so I can imagine more interest in lines that could potentially make a profit, although based on a similar money waster/vote-buyer in Victoria (the Melbourne->No-where line) perhaps not.
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I think creating new cities is a pretty radical response to lack of water on the south-east coast. Water currently costs about $1/kL and we know recycling or desal can produce water at $2-2.50/kL. Chuck in a CO2 cost and maybe it’s $3/kL. This would increase average water bills by a few hundred dollars per annum. Hardly something to get worried about. The main problem is that State Governments (apart from WA) have been caught unawares by the extent of the drought/climate change or whatever and haven’t done anything themselves or allowed market forces to function.
As for Russell’s point about inflation and mortgages, I think there is something to it. High inflation and interest rates meant that people could only borrow what they could afford to pay on their then-current income, which was rising quickly in nominal terms due to inflation. This allowed baby boomers to pay off their houses relatively quickly. Now that inflation is low, people can and do tend to borrow much more, while incomes are rising slower. This means that people will actually end up paying off mortgages over 30 years rather than 5-10. Whether that matters when living standards continue to rise is a separate question.
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BG, then could it be cheaper (in a budgetary sense) to do the same ‘good’ job with the dole as for family tax benefits, instead of cutting the lower tax rates for all taxpayers?
Rajat, you could do this of course – as long as you don’t mind the dole being used to subsidise people in low-paid full-time employment. Otherwise you have the unfortunate situation where you improve the incentives for people on income support to take up part-time work, but they find that it isn’t worthwhile taking a full-time job because they go backwards financially.
We are at the point now that the income point at which the dole cuts out for a single person can be very near the minimum wage, depending on individual circumstances. Any further relaxation of income testing could create a significant overlap with full-time wages, especially if the minimum wage does not increase as fast as welfare benefits.
So far in Australia we have largely kept people in full-time work out of the welfare system (while their partners and children may attract income transfers, by and large the workers do not).
Unfortunately, this is an area where there are no easy answers and most policy solutions have a downside. Cutting taxes across the board is much simpler and I think arguably fairer if you subscribe to the view that people should not be paying tax on an income that is significantly less than the income that we as a society consider the minimum required to keep body and soul together.
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Thanks Jeremy, Andrew and Sinclair! Most helpful. 🙂
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Nicely said, BG.
However, we are already past the point where the dole cutout exceeds full time Federal Minimum Wage for some single people. That’s why the Gov’t had to stick material in it’s Guide to the Social Security Law that covers how to pay an “unemployment” benefit to a person in full-time work.
Check this out: http://www.facsia.gov.au/guides_acts/ssg/ssguide-3/ssguide-3.2/ssguide-3.2.2/ssguide-3.2.2.10.html
But I have a feeling you already knew this.
Cheers
Spog
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my reading of previously SuperMac and now Glen together with other RBA papers has a consistent message.
There are supply constraints which I would have thought means any increase in demand will lead more in price rises than output.
Stephen’s assertion seems rather simplistic. It ignores a structural deterioration has far more impact on the economy than a simple budget deterioration.
You change the tax scales for example when company tax revenues are booming has implications when company tax revenues come back to the field.
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I have just seen Chris Richardson is singing the same tune
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Now Homer, some people can only sing one tune. The message out of Treasury was that government spending moved funds from high value use to low value use. In other words, government spending destroys value. Ken Henry is telling government to stop spending. The government collects too much tax. We know this because even though they are spending at historically high levels, they still run huge surpluses. Even after the government cannot justify spending another cent, they still have billions of dollars left over. So why not let the people who earned that money by providing productive capacity to the economy spend, or save, their own money as they see fit. Afterall, I’d prefer my money to be in my bank account rather than the Commonwealth’s bank account.
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by all means Sinkers but if they cut spending as well even Ken Henry anf Chris Richardson would be happy.
If only they were conservatives!
I am betting they cut taxes and increase spending and believe they can weather out the interest rate rises after the election!
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Homer, maybe you’d like to highlight in which sectors the price pressures would arise?
I thought inflation was a consequence of too much money chasing too few goods. Given that tax revenue is collected after the goods and services have actually produced – as Sinclair has already noted above in comment 17 – then giving wealth back to the people who created it shouldn’t produce inflationary pressures.
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This is typical Keynesian nonsense from Homer that only a specialist macroeconomist can swallow.
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Jason, were you referring to BBCLB’s comment at number25 on this thread? That seems to be more at the neoclassical end of the Keynesian-Neoclassical synthesis model of the macroeconomy. He refers to demand expansion resulting in inflation when supply constraints bind. The Keynesian part of the model relates to the case where there is a substantial amount of unemployment, so that there is excess capacity in the economy. In that case, demand expansion reduces unemployment rather than increasing inflation.
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if there are supply constraints I would have thought that it follows that too much money is chasing too few goods.
I do believe Keynes also talked about this precise thing.Neo-classical synthesis indeed.
Jeremy it comes up in most surveys of business. The RBA certainly highlights this and it appears to support their anecdotal evidence as well.
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Homer, where are the supply constraints, exactly?
What time period are you talking about? How quickly will people spend their money? Will it be sufficiently gradual to allow businesses to expand capacity (using the ocean of capital currently sloshing around world financial markets), so as to take advantage of the profitable opportunities that will open up following a tax cut?
If so, then tax cuts sound like a great recipe for non-inflationary growth. Closest thing we’ll ever get to an economic ‘free lunch’.
In a financial environment where most people can borrow as much money as they like, when they like, for whatever purpose – and are actually doing so – it seems bizarre to want to stop them from spending their own earned income.
Keynes was an odd economist, and got many things wrong. But his saving grace was that he was ‘cheerful’: he was always talking about the ‘upside’, and about opportunities latent in the economy.
Try being a bit ‘cheery’. Australia’s half a million unemployed will thank you for it.
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now that is very neo-classical. Conversion of financial capital to physical capital in no time at all. your supply constraints are met and hey presto give them all the tax cuts you want without ever having to cut spending.
As I said Jeremy most business surveys appear to be saying there are constraints around.
My guess is the new IR laws have allowed wages to rise less than may have happened previously but even so wage pressures are out there also IF you believe the same surveys
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‘now that is very neo-classical. Conversion of financial capital to physical capital in no time at all. your supply constraints are met and hey presto give them all the tax cuts you want without ever having to cut spending.’
I never said ‘no time at all’. I asked you what timeframe you are talking about. Nevertheless, we are talking about production increases at the margin – no need to rebuild the nation’s industrial plant, infrastructure and commercial buildings.
Say it took around one year for tax cuts to be fully spent by households – would that be enough time for businesses to adjust to the (marginally) higher demand?
‘As I said Jeremy most business surveys appear to be saying there are constraints around.’
Yes but wheeeeeeeere??????? There are always constraints around – that’s a sign that the economy is being well managed. The question is, where are the most significant ones – the ones with consequences for the general price level?
‘My guess is the new IR laws have allowed wages to rise less than may have happened previously but even so wage pressures are out there also IF you believe the same surveys’
Yes again, but wheeeeeere??? There’s lots of scary things ‘out there’. We need to know if the threats are significant, and if so can they be managed.
You sound as if you’ve been spooked by the ‘big picture’ commentators. But where exactly is the threat coming from?
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Jeremy, take a look at some RBA statements.
It could prove illuminating
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OK Homer: you make a statement, I ask you to flesh it out, but rather than oblige me you tell me to myself go and find support for your argument?
You’ve got to be kidding.
I’ve read the RBA statements, and more than once. I know what they say.
I’m asking you these questions because I want to know if you know what you’re talking about.
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