Tax cut fight shows we're back to the same old Labor - The Centre for Independent Studies

These calls increased in the wake of the RBA rate cut, with Labor MP Anne Aly going even further – claiming that Australia couldn’t afford tax cuts when it looks like we are going into a recession.

Shadow Treasurer Jim Chalmers suggested abandoning the broader tax reform agenda and bringing forward spending instead.

Of course these plans sound exactly like what they were talking about before the election, suggesting little or nothing has changed in Labor’s fundamental economic approach despite their stunning election defeat.

These arguments are usually rejected by those on the right on the basis that deficit spending will drive up debt, leaving a burden for future generations to pay off.

While this is undoubtedly an important reason to reject Keynesian deficit spending, it is neither the only reason – nor even the most important.

First, fiscal stimulus is largely ineffective in an open economy with a floating exchange rate and a central bank doing its job. Spending leaks away to boost imports.

At a minimum, any effect of fiscal stimulus is overwhelmed or offset by monetary policy.

Some economists, like Scott Sumner in the US, have estimated that the so-called ‘multiplier’ – where government spending has an amplified effect in the economy – is actually 0, suggesting fiscal stimulus is completely ineffective.

Even if fiscal policy can effectively control GDP in the short term – which is itself debatable, given various lags and its inevitably poor targeting – fiscal stimulus cannot generate sustainable economic growth.

And the real problem is not a short term collapse in growth, but being trapped in a long-term trend of slow growth.

Government stimulus, especially at the federal government level, is almost exclusively about boosting spending.

Yet economic growth is not about consumption, it’s about production.

Spending follows production, it doesn’t precede it. An increase in spending not matched by an increase in production merely creates inflation, effectively reducing living standards.

Yet in a market economy, an increase in production that does not attract spending is redirected into different, more desirable production, increasing efficiency (and ultimately living standards).

To the extent fiscal policy can be effective in generating growth, it is on the supply side – providing adequate infrastructure to enable production, reducing the burden of regulation, and limiting the effect of government on the efficient allocation of the market.

This is why tax cuts are important. They encourage investment, innovation and ultimately productivity.

It is not because unfunded tax cuts can have a short term stimulatory effect – the stimulus only increases demand, not supply.

Because discretionary stimulus is by its nature temporary, there is no reason to think it will lead to a sustained increase in either spending or production.

On the contrary, fiscal stimulus relies on “fooling” business that either consumers will make permanent spending decisions based on temporary increases in income or that stimulus can be sustained indefinitely with no fiscal cost (ie. tax increases.)

If it works, it is more luck than design. Instead, the government would do well to heed the advice of new Productivity Commissioner’s calls for a “fresh agenda” to economic reform and scrapping of the most inefficient taxes.

Government spending should be assessed on its merits, or lack thereof, not on the basis of spurious claims about macroeconomic benefits.

And when weighing up government spending, one factor that must be kept in mind – regardless of the fiscal cost or effect – is that increasing the size of government always comes at the cost of a reduction of freedom.

One the most egregious flaws in Labor’s election campaign was its moral conflation between a reduction in taxation and an increase in spending.

“Allowing” someone to keep their earned income is not the equivalent of taxing others to give handouts to favoured groups. It is most certainly not a “rort” or some sort of scam or con.

And for the record, your entitlement to your income is not a right you sign away just because your income is above average.

Labor arrogantly claimed the right to make decisions about so-called “rich” retirees’ income, whether it was “fair” to allow them to keep it or manage it themselves, on the basis that those with lower incomes (and of course union-dominated industries and super funds) had a greater right to that money than those who earned it did.

This is why Labor is doubly wrong to now call for abandoning tax cuts in favour of more spending as a stimulus.

Deficit spending is problematic not only because it creates debt but because it increases the size of government.

And that increase has a cost of its own – and not merely an economic one.

The point being there is a big difference between government spending at 50 per cent of GDP and 20 per cent of GDP, and it is not OK to spend 50 per cent of GDP just because you also tax 50 per cent of GDP.

Every time government expands, it takes decisions away from individuals and makes them itself instead.

It decides what you want and what your priorities are. This is unfair.

The Coalition touched at the edges of these arguments during the election campaign, but have long since shied away from fully embracing the fairness of smaller government.

Amazingly, the electorate seems to have been shaken out of its passive acceptance of ever-increasing government anyway. Perhaps this is Labor’s greatest mistake at the last election.

By unveiling a fiscally responsible plan for comprehensive tax increases to fund their spending program, they let slip the real cost of big government. The government has a real chance to reset the economic debate and move the focus away from the supposed need for more government spending. We need them to take it.

Simon Cowan is research director at the Centre for Independent Studies.