Last week we had an extensive debate on whether tax cuts would be inflationary or not. Over the weekend Newspoll was finding out how many voters buy this line, and the answer seems to be at least 30%. Though both ACNielsen last week and Newspoll this week find 66% of their respondents want a tax cut, Newspoll followed up with this question:
Some economists believe that giving personal income tax cuts in the budget may lead to a rise in interest rates. Given this possibility, would you personally be in favour or against income tax cuts being given in the federal budget?
At which point support for tax cuts dropped to 36%. It seems that Australian public opinion has moved from tax and spend to tax and don’t spend, which is possibly even worse. Winning obscure macroeconomic disputes may be important to attempts to stall Australia’s ever-expanding state.
Andrew Norton 
It would have been great if Newspoll had asked the same question to those who preferred spending on services.
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Apparently I’m not the only one who has learned from 19th c. novels, the government too has taken Micawber’s advice:
“”Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
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But Russell, no one’s talking about going into a budget deficit!
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I think tax and not spend is a good idea in current boom times if a counter cyclical budget becomes the norm (including having deficits in recessions). Somehow I doubt it that it will ever eventuate however.
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the silence has been deafening from so-called conservatives who want tax cuts but do not want to advocate spending cuts as well.
My guess is that Howard will indulge in both tax cuts and spending in the hope any rate rise comes after the election.
Who thought up this theory if that the surplus only needs to be 1% of GDP and you can get rid of anything else in tax cuts or spending?
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Homer – There is more than $10 billion unspent, so that’s an excellent source of tax cuts. Then we can start on family payments, the private health insurance rebate (though that’s just tax cuts under another name less bureaucracy), the unnecessary stopgap planes for the air force, and industry assistance. There is plenty that could and should be cut.
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Andrew,
I agree there is plenty that could be cut. I can’t see Howard cutting FTB although he should indeed I think we are in agreement in most of what could be cut.
My political antenne however says the budget will be about tax cuts and spending.
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I don’t mind if they scrap the private health insurance rebate but if so, they must scrap the Medicare surcharge for those earning above $50K. The surcharge was brought in at the same time as the rebate. If the rebate goes and the surcharge stays, I am effectively forced to pay even more to purchase a product I don’t want or else pay 1% more of my gross income in tax.
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But what will happen ifthe rebate goes? How many people will not have insurance and will therefore fall back into the public system that can’t cope as it is? Is there any going back?
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Unfortunately I can’t get hold of the article mentioned in today’s papers about the rebate. But in data I have seen before, private health insurance is most common among high-income earners, who would be the main beneficiaries of tax cuts (because they pay most of the income tax bill). They will still be able to afford private health insurance.
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If they chop the 30% rebate, likely it will get a bit cheaper to have private health insurance. The insurers managed to sneak in more than 30% of rises into their premiums after the rebate was announced. The private health insurance rebate was always going to be a farce though – the feds were told when they announced it that it would simply make premiums more expensive and look what happened.
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The AIHW has old figures :
‘The greatest immediate influence on the level of coverage was the lifetime health cover provision. Coverage increased from 32.3% at the end of March 2000, to 45.8% at 30 September 2000, reflecting the full implementation of the Commonwealth Government’s lifetime health cover arrangements during the September quarter.”
If the more than 40% are covered now, they can’t all be high income earners.
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43% according to PHIAC.
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“Some economists believe that giving personal income tax cuts in the budget may lead to a rise in interest rates.”
Some economists ought to be fired.
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#14 Mark, I am sure you will find these are the same economists that favour an increase in spending instead.
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Yeah, because spending money on things with negative rates of return on investment won’t reduce the supply of loanable funds…or make capital more scarce…
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Perhaps some economists should be named and their allegiances identified before we treat what they say with anything but a grian of salt.
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It is very easy to give a plausible explanation as to why a decrease in tax might result in an increase in interest rates. Consider a closed economy at full employment. This means that Y=Y0 cannot increase, at least in the short-run. To keep things simple, I will only focus on the goods market. The goods market is intially in equilibrium: Y0=C(Y0-T0)+I(r0)+G0. Government taxes exceed expenditure: T0>G0. Suppose that the government reduces T0 to T1, where T0>T1>G0, but does not chgange government expenditure. Then, assuming that the marginal propensity to consume is greater than zero, we now have disequilibrium in the goods market: Y0
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For some reason, the bnottom part of my previous comment got deleted in transit. Weird!!! It basically said:
We now have disequilibrium in the goods market: Y0r0 such that: Y0=C(Y0-T1)+I(r1)-G0. While this model is very simple (indeed, it is probably overly simple), nonetheless, the insight is very clear.
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Again, part of the comment got deleted. Between Y0 and ro in the third line of my previous comment, there were a number of sentences. I’ll leave the equations outr, in case that is what is causing the problem. The basic point is that with output fixed at the full emnployment level and assuming no decrease in government expenditure, then investment must fall in order to restore equilibrium in the goods market following a reduction in taxes. If investment is to fall, then the real interest rate needs to rise, because investment is a decreasing function of the real interest rate.
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You were doing so well, until you got to “consider a closed economy”. Can you give us a plausible story why tax cuts next Tuesday night will cause inflation in Australia?
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Sinclair, an open economy doesn’t change the underlying logic dramatically. Clearly the initial impact of tax cuts is an increase consumption which leads to an increase in demand if there is no reduction in government expenditure. Unless you believe that the marginal propensity to consume domestic goods is zero?
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Are you claimimg that the increase in dometsic consumption and the increase in imports is going to exactly offset each other? Because thats the only case where I can see there being no impact on the interest rate and the price level. This seems to be a very unlikely situation.
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I suppose it is possible that the increae in imports might exceed the increase in domestic consumption, in which case, the interest rate would need to fall!!! I wonder how likely this in in practice, however?
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Damien, you’re playing ‘assume a can-opener’ games. There must be a very large number of ‘plausible stories’. It’s all good fun. But the consumers of economic information don’t want plausile stories, they want the likely outcome. Producers of economic information like to discuss ephemera. You need to be more consumer orientated. Do you think it is likely that tax cuts next Tuesday night will cause inflation?
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That is kind of the point Sinclair. Mark suggested that economists who believe that tax cuts will lead to inflation ought to be fired. Presumably, this is because he doesn’t think there are any sensible economic arguments supporting this. I provided you with an argument that suggested that tax cuts might lead to inflation.
Do I think they will? I don’t know. I certainly think that it is possible that they might. The fact that they might lead to inflation does not make them a bad thing. People care about more than just inflation. It also depends on the alternative. If the al;ternative is the Howard government spending money willy nilly on silly things, then tax cuts would be a better alternative.
As for can openers, that old criticism is just plain silly. Assessing policy options in the absence of a theoretical framework gets you nowhere.
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Well, what happened to interest rates after the last tax cut?
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Nothing.
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Nothing wrong with a theoretical perspective – just you’ve only got a theoretical perspective. stick your neck out and take a stand.
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A pity I don’t understand statistics because I’m looking at all these types of interest rates at the RBA site and it looks like they did go up after the milkshake and hamburger tax cuts.
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In historical time interest rates are higher now than they were at the last budget. But you need to argue that interest rates went up as a consequence of tax cuts. That argument, you’ll find, is very difficult to sustain.
From my February AFR piece
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Here’s an interesting comment in today’s Age:
“Macquarie Research head of economics Richard Gibbs said tax cuts would be unwise, and spending should instead focus on areas that boosted productivity such as infrastructure, education and child care.”
Ok, perhaps childcare could increase labour supply by more than it increases labour demand. But surely spending on infrastructure or education will boost demand by far more than supply in the short to medium term (1-3 years)? And if so, surely that would be more inflationary than tax cuts at this stage in the cycle? I thought private sector economists were usually more measured when they opined to the media.
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Though childcare is an example of why price increases in particular sectors are not necessarily bad – higher pay is needed to attract and retain quality workers in the industry.
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If the government wanted to boost child care places they’d make it easier for companies to provide that care on site (or in close proximity). I seem to recall there was a change several years ago that added to corporate child care costs. So reverse that decision, whatever it was. I would also consider removing fringe benefits tax on company provided child care (it would be a small thing to do, but there are probably heaps of small things that can be done – not to mention the big things that should be done).
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Well, obviously we get the childcare workers people are willing to pay for! Arguably, quality childcare confers some positive externalities, but childcare is already heavily subsidised. If you removed FBT on corporate childcare, presumably you would also have to make childcare fully (privately) tax deductible to ensure consistency with those who don’t have access to corporate childcare. The question is then whether this would be the most efficient way to increase workforce participation.
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I wouldn’t necessarily make childcare tax deductable for consistency reasons. I would only make it deductable if it increased participation. Removing child care FBT for companies would promote participation by definition (although the effect my be small, I don’t know). Companies that wanted to employ more women would then compete on working conditions.
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Wouldn’t that introduce a bias in favour of women working for larger companies rather than small to medium firms?
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Maybe.
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“The question is then whether this would be the most efficient way to increase workforce participation.”
“Wouldn’t that introduce a bias in favour of women working for larger companies rather than small to medium firms?”
If you believe, as I do, that women are the most likely source of increased labour force participation (prime age women is the main group where labour force participation in Australia lags behind most of the developed world), then additional subsidy for child care, one way or another, will probably be required. Either that, or fertility will continue to fall (resume falling).
In the end, while child care is not solely a women’s issue, most people would see it as a cost that effectively falls on women, as predominantly second earners. This does mean that many women do face a financial barrier or disincentive to working that is not apparent to most men.
As to whether women might have a preference to work for bigger organisations, I would have thought that is already the case – as well as a better career structure, larger firms (and government departments, of course) are much more likely to offer benefits such as paid maternity leave, permanent part-time work and other ‘family-friendly’ flexibilities that women are likely to be seeking.
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Whether high levels of workforce participation by mothers with young kids is a good thing per se may be difficult to tell, but I guess the untaxed nature of home work plus FTB Part B creates a distortion in favour of women staying at home.
I think a reasonable outcome (in my dreams) could be to get rid of FTB Part B and use that to fund childcare subsidies. What do you think BG?
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Rajat – It all depends what you mean by young kids, I guess. The trouble with kids and child care is that I suspect it really is a case of ‘horses for courses’ – I think that child care (even full-time) does no harm to lots of kids, but there are others for whom it is not a good solution. (Of course, I would like to think that my own children are in the ‘not harmed’ category, but they might have another view.)
Putting the money into child care subsidies does of course require government to make an explicit decision that it wants to encourage mothers to work, at least part-time, rather than just hiding behind the official rhetoric that they support all choices. Of course they don’t support all choices equally, as you point out. If they did, perhaps they would have some kind of universal payment for young children, rather than a means-tested one which inevitably has to then be withdrawn when the mother enters the workforce.
But certainly if I had my druthers I would support more money into child care (simplification of the current horrendously complex arrangements would also be good) rather than more means-tested family assistance, which only increases the incentive for women to withdraw from the workforce for long periods of time.
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