Tax cuts are risky, but now’s not the time to create a buffer either
Voters will be faced with a gut wrenching choice when they roll up to the voting booth in May: what’s in it for me versus what’s best for the economy. In negotiating this minefield beware the populist policy that promises a sugar hit but undermines an already weakening economy.
Commodity prices have blitzed Treasury’s conservative forecasts. They’ve absolutely shot the lights out. So there is a better than middling chance a healthy stash of flash money will be on hand to buy votes in the lead up to May’s election. Our national fiscal accounts are in good shape.
We knew this was coming. The December mid-year economic and fiscal outlook (MYEFO) showed government revenue overshot estimates by $8.3 billion due to stronger than expected income and corporate tax receipts - jobs growth and high commodity prices did the heavy lifting in tandem. This reflected economic, rather than policy, parameters.
From there things just got better, on the commodity price front at least. Iron ore is currently fetching 60 percent more than Treasury’s MYEFO forecast of US$55 per tonne. Metallurgical coal is running 65 percent ahead of estimates. Thermal coal is actually in the ballpark, although it too was up around US$98 per tonne in February, beating Treasury’s US$93 per tonne forecast.
Ongoing windfalls from income tax seem unlikely given that although the labour market has been strong (over 150,000 created in the first half of fiscal 2019), employment growth is slowing and the economy has lost significant momentum. But mining profits remain strong.
Already there is speculation about a projected revenue windfall allowing the government to bring forward the timing, or increase the size of its package of staged income tax cuts announced in the 2018-19 Budget. The MYEFO set the scene for that, earmarking almost $10 billion for revenue reducing policies (read tax cuts) yet to be announced. Now there’s even more cash.
And the temptation to use it to buy votes is strong.
Against the backdrop of a weakening economy, however, the vote winning policies of both parties are looking increasingly irresponsible.
Ideological positions between the two major parties may have converged on some issues over the years but how to spend a revenue windfall is not one of them.
The federal Liberals have a long-standing commitment to keep tax revenue to less than 23.9 per cent of GDP. It’s a commitment to not over-tax and encourages spending restraint. The health of the economy means the budget is now heading towards that ceiling.
The Liberal party will be wary of the ratio creeping higher. The commitment to a cap may force their hand and increase their focus on cutting taxes.
Labor, on the other hand, would have more options to increase spending in schools, hospitals and infrastructure.
The Opposition has not committed to a cap, although Opposition Treasurer Chris Bowen has committed to keeping tax to GDP low by international standards. Labor’s current tax policy platform is forecast to raise an additional $280 billion over the next decade mainly through changes to capital gains tax concessions, negative gearing and franking credits.
Mr Bowen has pledged to use this tax revenue to rebuild a fiscal buffer. Given his proposed reforms will do that for him, there is little pressure to push for additional tax cuts in preference to greater spending initiatives.
With the national revenue base more fragile compared to just a few months ago, and with monetary policy close to its limits, building a big buffer might not be the best call.
In an economy where growth is slowing and monetary policy doesn’t have a lot of buffer left, it’s worth noting that income tax cuts are cumulatively expensive. For example, the Low and Middle Income Tax Offset announced in the 2018-19 Budget was described as offering enough money for a “burger and milkshake” each week, but costs the Government several billion dollars annually. Also, with consumer sentiment waning, there is a question surrounding people’s willingness to spend a tax cut.
History shows that from an economic perspective spending can’t just be about buying votes.
In terms of shoring up the economy, neither tax cuts or spending consistently comes out on top. As a bulwark of our economic prosperity, voters will be faced with a conundrum when they roll up to the voting booth in May. With storm clouds brewing for the economy, balancing populist ideas and short-term gratification against what keeps the whole nation humming will be important. But that’s not always easy and the pull of ‘what’s in it for me’ and what ‘feels right’ is strong.
Living wage is a perfect example. Prime facie it is rousing idea. Culturally we believe in equality and citizens’ right to maintain a basic standard of living. But if you jack up wages by 6 per cent in one hit, in a slowing economy with weak productivity growth, you’d be a reckless to think there won’t be a response in the jobs market.
Spending to buy votes in a way the produces sustainable productive growth is a balancing act at the best of times. But in a weakening economy even more so.