Ideas@TheCentre brings you ammunition for conversations around the table. 3 short articles from CIS researchers emailed every Friday on the issues of the week.
Surplus of $7.1 billion is mostly due to higher tax
The government has announced a small budget surplus of $7.1 billion for the coming year (2019/20) and slightly higher surpluses into the future. While balancing the budget is good news, unfortunately, this has been largely achieved through higher revenue, with tax receipts growing from 21.3% of GDP in 2013/14 up to 23.3% in 2019/20.
Spending continues to rise
Government spending continues to increase, despite rhetoric to the contrary. While the government correctly claims some credit for keeping real spending growth down to 0.7% in the coming year, it should be noted that most of this ‘spending restraint’ has come through parameter variations that are out of their control. Over the past year, the government has actually announced $6.2 billion worth of new annual spending. In addition, the government has committed to $100 billion of infrastructure spending over the next decade, much of which will be outside forward estimates, or off budget altogether.
Bad modelling exaggerates impact of tax cuts
The government has announced income tax cuts in two stages; which they value at $19.5 billion over the forward estimates (four years) and $158 billion over the next 11 years. These numbers are almost certainly an overestimate, as they fail to factor in behavioural change. The CIS has modelled the long term tax cuts and yesterday released more accurate estimates, based on our dynamic tax model.
Short-term cuts should be scrapped
The first stage involves an immediate increase in the ‘low and middle income tax offset’ (LMITO) from $530 to $1080 per year. Tax cuts are always welcome, but this type of tax reform is neither transparent nor efficient. Most commentators have focused on the dollar value of the change, but it is the marginal tax rates that determine the efficiency of a tax system. The good news is that the proposed changes will decrease the marginal tax rates for people earning between $37,000 and $48,000, from 33% down to 28.5%, but the bad news is that it will increase the marginal tax rates for people earning between $90,000 and $126,000, from 40.5% up to 42%. The government should scrap the first stage and jump immediately to their long-term plan.
Long-term tax cuts should be moved forward
To their credit, the government’s long-term tax reform is transparent, efficient, and much needed. These reforms involve scrapping the LMITO, increasing the tax threshold for the 32.5% tax bracket from $37,000 up to $45,000, and then lowering the nominal 32.5% tax rate down to 30% (not including the Medicare Levy). However, this reform also relies on the government staying the course and in power so it’s not guaranteed.
The government had already planned to increase the 32.5% threshold to $41,000, but this has now been extended up to $45,000. People earning below the threshold would pay nominal income tax rates of 19%, plus the Medicare Levy. This tax reform is to be applauded and is a significant improvement over the status quo and the first stage. However, it should be moved forward and implemented immediately.
Bracket creep is still a problem
Unfortunately, the government again failed to index the tax brackets. If income tax revenue grew at the same rate as average wages growth, then we would expect income tax revenue in 2022/23 to be around $261 billion. However, income tax revenue tends to grow faster than wages due to bracket creep. Even factoring in the government’s proposed new tax cuts, income tax revenue is expected to grow to $264 billion by 2022/23. This highlights the need for the government to index the income tax brackets and remove the stealth tax of bracket creep.
Actual tax rates
The government claims their current income tax rates are as follows:
This is misleading, since it does not factor in the Medicare Levy (ML), or the Low-Income Tax Offset (LITO), or the Low and Middle Income Tax Offset (LMITO). Following the 2018-19 budget, the actual tax rates were as follows:
With the updated tax policy announced in the 2019-20 budget, if made into law, the actual tax rates would be as follows, with the changes highlighted in red.
Just as Sydney was sinking deeper into the morass of a lockdown and Victoria was about to re-enter that familiar territory, the Australian Bureau of Statistics reported a week ago that the national unemployment rate had fallen below 5 per cent to its lowest level in 10 years.
But that was in June, and it is likely to be the last piece of good economic news for some time. So rapidly is the economic rebound unravelling – South Australia also joined the lockdown fray this week – that calls for the resurrection of JobKeeper and fiscal stimulus more generally are growing louder.
It is true that Australia had enjoyed a stunning economic rebound up to the end of June, but the role of fiscal policy in this needs to be carefully assessed before further measures are considered.
The fiscal policies of 2020 have been described as a triumph of Keynesian economics and a template for all future macroeconomic setbacks. One typical recent commentary along these lines in The Guardian proclaimed that the lesson of the past year or so is that “fiscal stimulus works”, “governments can create jobs”, and we should be forever grateful to John Maynard Keynes for providing the blueprint.
This is being far too generous to Keynes and his General Theory. Let’s be clear: few would suggest that fiscal policymakers should have sat on their hands in the circumstances of 2020.
But those circumstances were unique, and the policy responses that might have been appropriate then cannot be generalised as a prescription for all economic setbacks.
Economic activity was depressed by government edict. It bounced back when the edict was withdrawn. Fiscal policy facilitated the rebound through JobKeeper (which kept intact many employer/employee links that would otherwise have been severed) and various stimulus measures that supported household budgets and business cash flows. The sums were massive and – at least with the benefit of hindsight – more than was warranted.
If governments flood every crevice of the economy with borrowed money, there will doubtless be a boost to economic activity – especially when it is backed up by monetary policy that nails interest rates to the floor and creates new money by scooping up copious amounts of the government-issued debt (quantitative easing). But this is not a recipe for the future.
Yes, fiscal stimulus can work, but its effects will always be short-lived.
Yes, fiscal stimulus can work, but its effects will always be short-lived.
Yes, fiscal stimulus can work, but its effects will always be short-lived. And the question will always be “what comes next?” Stimulus brings forward economic activity from the future. That can serve a useful purpose in smoothing the business cycle, but it is always going to be exceedingly difficult for governments to get the timing right.
Policymakers also need to be alert to the potential longer-term problems created by short-term stimulus measures. One of these is the risk of unleashing inflation by over-heating the economy – a very live issue now, with inflation rising in some countries.
Other potential longer-term problems include distorted incentives and the difficulties for future fiscal management resulting from a build-up of debt. Economic actors know that today’s budget deficits can lead to tomorrow’s tax increases and adjust their behaviour accordingly.
The experience with fiscal policy during the pandemic is interesting but has done nothing to strengthen or weaken the case for fiscal activism to manage the economic cycle in the future.
Governments will always do it, but they should always be cautious. That advice applies right now, as the Morrison government is urged to step up fiscal support and stimulus again.
Scott Morrison should do as much as his government considers necessary and prudent, not what state governments and others might urge.
The main game for fiscal policy should be mapping a path back to a balanced budget and doing what it can to provide incentives for private sector activity that will strengthen economic growth over the longer term.
Anything else is a short-term detour.