Redirect, Defer or Deliver: the income tax cut dilemma

There seems to be a very widespread view amongst economic and other commentators that it will be a bad thing for the economy, and particularly for efforts to contain further growth in inflation, if the government goes ahead with its election promise to implement a further 31 billion dollars in income tax cuts.  It should be remembered that this is on top of another 26 billion dollars in tax cuts which is about to cut in as a result of last year’s Budget – making a total of 57 billion dollars in tax cuts impacting over the next three years.

Given that more upward pressure on inflation makes it much more likely there will be further hikes in interest rates, with further pain for many people already struggling with home mortgages and/or businesses with borrowings, there is a strong argument for cancelling or at least deferring these tax cuts. I can understand why the new government is keen not to be breaking major election promises so soon after being elected. I have a recollection that the Whitlam government took the same view of determinedly implementing their promises upon election, even when they realised some of them were dumb or dangerous ones. This approach may have saved them some electoral brownie points in the short-term but cost them dearly in the long-term as it compounded some of the economic problems which rapidly befell them – sometimes for reasons outside their control, sometimes not. 

It is possible the Rudd government is also just buying itself larger amounts of pain down the track by sticking to its initial promise, which was economically unwise even at the time and with the rapidly worsening inflationary forecasts which have appeared since, now looks “positively crazy” according to former Reserve Bank board member and ANU based economist, Bob Gregory.

An alternative to just deferring the tax cuts which is being widely floated is to put them over into superannuation, where they would add to long-term savings rather than mostly being injected immediately into further spending. This is seen as sort of keeping the election promise (although I don’t think it does really), whilst being more economically responsible. 

Rogg Gittins says that “if Mr Rudd simply can’t summon the bottle to defer the tax cuts, the obvious compromise is to direct them into superannuation. Tax cuts that are saved rather than spent aren’t stimulatory.

And here Labor could greatly reduce the political backlash by taking up a clever proposal by Dr Nicholas Gruen of Lateral Economics that’s based on a well-researched finding of behavioural economics.”

Nicholas Gruen has suggested a variation which I think has some merit – to divert the tax cuts into superannuation, while still giving people the choice to opt-out of this arrangement and take the tax cuts if they wish. Apparently research shows that in an ‘opt-out’ arrangement like this (as opposed to an ‘opt-in’ set up), the majority of people will leave their money going into superannuation.

One interesting dissenting opinion about this sort of approach comes from the blog of the Canberra Times’ economic writer, Peter Martin. Despite all the calls for the cuts to be put into superannuation, he says “it would boost even further what is easily the most subsidised, protected, and essentially unproductive industry in Australian history.”

“Presently costing $26 billion, and ballooning at the rate of an extra $2 billion each year, the annual cost of the tax incentives offered to encourage people to put extra money into super dwarfs that of actual government programs. By way of comparison the Commonwealth government spends $16.6 billion on education. The entire ACT government spends less than $3 billion on all of its services rolled in together.

What’s wrong with further feeding the ever-growing superannuation monster, as just about everyone who has Wayne Swan’s ear seems to be suggesting?

Super is already big enough.” (my emphasis)

Like almost everyone else, Peter Martin agrees that “The government does need to take money out of the economy on a temporary basis at the moment in order to tame inflation.” But he dissents in his views that “it doesn’t need to lock it away in super where we won’t be able get it when we need.”

Which I guess leaves us back at deferring the tax cuts (which would have the added benefit of reducing the pressure for government spending cuts, some of which is no doubt wasteful but some of which will inevitably lead to windbacks in valuable community services.) Although in a later comment on his site, Peter Martin points to the example of the Norwegian Petroleum Fund, which invests excess surplus offshore until the day when it might be better deployed to provide an economic stimulus at home.

However, I think it is a fair bet none the less that political reality will triumph over economic reality, and the tax cuts will go ahead basically unaltered, which will mean sizeable tax cuts in spending to try to balance its inflationary impact – unless the Liberals decide to reverse their own pre-election promises and opposed the tax cuts in the Senate, which seems very implausible to me, but would at least shake up some political paradigms and provide a way for the Libs to demonstrate a much-needed break from the Howard legacy of economically irresponsible vote-buying which is part of the reason this particular dilemma exists.

UPDATE: As a reminder that not everyone agrees with the ‘tax cuts will fuel inflation hypothesis’, read this piece by News Ltd’s Terry McCrann.

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15 Comments

  1. The error of Peter Martins comment is that subsidising superannuation now should be looked at as reducing Government spending in the future rather than as a net loss to revenue.

    Until no person living in poverty pays taxes and the tax thresholds or rates are indexed the game of rewarding us with our own money will continue, and continue to piss me off.

  2. And they havent made up their intelligent collective ,university educated minds wether or not after lobbying from Aboriginals that their is an obligation on their university educated intelligence that the obligation is one the university educated intelligence should opt in as their own.Then again if you listen to Delroy after ten o clock at nights Clive Hamilton has written a book… the endangered 35 near year olds suggesting they need to start downsizing their work responsibilties,because after all,Delroy an older genius,has recognised all the near 35 year olds have their houses paid off,are ready for the super to be paid into their bank accounts,and the tax cut should go into their lovely sized super funds.Without exception of course,the problem of wether the Rudd government should or shouldnt break its promises ,the more important ones ,I suppose, is to insure that the less important ones ,like all unemployed should be in the participation figures of newspaper adverts, about jobs which means that then Rudd ,can justifiably say he represents All Australians about employment when the government has evidence,people like myself apply for jobs City and mines,and do so on the University educated advice of MacNamara on Sundays of waiting till the job that suits you.. is available!?I need a few things though,like a machete,to clean my toe-nails!Its not what the country can do for you,its what the country wont ever do for you,and the reason is overseas money,and money overseas,and who oversees the bloody money!?

  3. I think most people accept that there would be good reasons for the Rudd Government to break its promise this time around and not deliver the tax cuts. On the other hand, Rudd is no doubt acutely aware that the tax cuts were promised to the electorate, and he is likely quite keen not to do a Paul Keating “L-A-W” thing and double back.

  4. Those “good reasons for the Rudd Government to break its promise this time around” would be the same reasons for the two party system not to have offered the carrot made their respective promises in the first place. Despite the dubious “rapidly worsening inflationary forecasts”, it’s not as though a whole lot has changed since electioneering a month or three ago.

    Still, if Chairman Kev’s going to break a core promise, better to do so before the masses (well, 43% anyway) take off their rose coloured glasses.

    Andrew: Remember that “Me-too Kev” effectively embraced the aforementioned “Howard legacy of economically irresponsible vote-buying which is part of the reason this particular dilemma exists”. It’s what this thread is about after all.

    Indeed we may be headed towards bipartisan supported reversal of pre-election promises. What a joke.

  5. Perhaps Rudd could sink the money into retrofitting existing homes with solar hot water, solar panels (with SA’s new feed-in tariffs, this would be fantastic news for home-owners), insulation, water tanks and other energy/water efficiency measures that will have the effect of reducing the amount families spend on their electricity, gas and water bills.

    Rather than giving the nation temporarily more money through tax cuts, we can cut their expenditures permanently.

  6. Couples might need the taxcuts to pay their mortgages and/or childcare – not to go into super. I think that would be stupid. It’s best to pay your debts before you save for the future.

    Rudd could try to implement SOME of his promises, while holding some back. Surely fair-minded people will understand.

    I hope he is FIRSTLY going to raise the taxation threshold for disability pensioners under 65, so that they are on a more level playing field with sole parents and aged pensioners.

    If not, the Taxation Department will get a sizeable flea in the ear from me at the end of the financial year. Again! Peter Dutton can have 2 fleas.

    I think Gough Whitlam was the most arrogant and stupid politician ever, in gambling away our nation’s assets. I was forced to vote for Malcolm Fraser just to get rid of him.

    With regard to superannuation, the tax incentives primarily benefit the rich. I am also still suspicious as to whether or not they help people get out of paying their child support.

    I wouldn’t advise anyone to put extra money into super. Since most of our money is controlled globally, I think global opportunists will eventually empty the kitty.

    If Rudd needs extra money, he should shake the moths out of John Howard’s wallet and access the funds they’ve been guarding.

  7. Coral,

    The ideas I put forward in my post will allow everyone to cut their energy and water bills, giving them extra money to pay for their child care and mortgages. Putting the money into this home infrastructure will provide jobs (a mix of skilled and unskilled), reduce our impact on the environment and allow people to spend the money they’ve saved on things like child care and their mortgages.

    Keating, last February, recommended any future tax cuts go in to superannuation where they can work as investments rather than being spent in the short term. The only problem I have with this is that super funds continue to be invested in things like coal mining and cigarettes and the other “boom” industries which aren’t exactly socially and environmentally friendly.

  8. Sam Clifford #5 & 7:

    Solar panels, insulation, & water tanks

       COST = $$$$$$
       BENEFITS = cents

    … and that’s why we’re not running around paying for them (without subsidies) and fitting them in droves … no return on investment)

    Also it hardly addresses the claimed government’s “need to take money out of the economy”.

    Could be a bit of an environmental impact from all those solar panels as well but may be pleasing to Gaia and the Greens.

    I’m not living on the borderline, but if I was, I’d be more interested in food on the table, and the well being of my family.

  9. Do I hate the words skilled and unskilled,more so when someone is suggesting to the authorative clamour that their skills seem like a puny calorie burn.Sam is being that… well intentioned word,positive,but for goodness sake there are so many agendas going on about tax cuts and Summits,the enlightened may well wonder,if the previous sets of nongs who run superfunds and where they invest,as humans not tarnished by such descriptions as skilled and unskilled,from many areas of so-called professional status devoid of the skill word in two forms,simply were now subject to at every loss of monies in superfunds..to criminal intent…bad investment by accepting advice….inflation as in the U.S.A…devalueing of asset investment by initially raising value by takeover but leaving a transfer of possible debt servicing by increased asset investment..trusting figures on the basis of them being communicated transparently…investing in assets without physical inspection…no accounting for below key personnel change…and any number of other matters happening that they didnt do in their previously accepted job conditions..coming to the job of managers without any likelihood of understanding the enormity of potential problems non -super citizens put up with over the rights and not benefits of superannuation holders..in their previous jobs,and now upon those on welfare…bludging bastards,sorry this is a long sentence,…….had to meet the changes in the market place as pay description and conditions other than the workplace..with the standards of the market leading the value,with no right to estimate inflationary aspects as moment of being paid..they would have to hump their cliche…I have worked hard all my life,..back to the mental state inherent in the 1930s digging holes and refilling them,because the only difference between investment and shovels are the lack of counting the hands connected and perspiration a side function of calorie burn.Slim and alive they maybe.

  10. Rudd has 3 years to convince us that not following through with the tax cuts is actually better long-term for us all — however given the card-board cutouts on the Opposition benches (when they bother to turn up at all) I don’t suppose anything principled will be let go unbesmirched. I am not sure of the rationale for the Friday sittings, and maybe they need to be re-thought, but as someone who lives in a Coalition-held electorate, I am ashamed of last Friday’s stupidity, thank goodness I didn’t vote for them.

  11. I agree Sam that this may be a better use of government revenue – both in terms of equity and sustainability. However, as GZG said, it doesn’t address the concern about the inflationary aspects of pouring more money into the economy at this time (assuming you accept that concern, which not everybody does – see Terry McCrann link added at the end of my post).

    Although it does also link to one of the other criticisms that is being made with persuing the tax cuts – that it will mean harsher cuts into other government spending (including potentially that of the type which Sam is proposing) to balance out the money beintg injected by the tax cuts.

  12. Rudd has found himself in a tough place on this issue of tax cuts. He obviously wants, and needs, to make his government look different to the previous bunch. A great way of doing that would be to keep his election promises (who can forget John Howard and the Non-Core Promise?!) Actually keeping his promises would immediately highlight the differences between Howard and Rudd. Even if some of them are stupid promises.

    I like the idea of opt-out super contributions. Extra super is a good thing, I think, but I like the idea of tax cuts, too. With rising interest rates, right now is when I’d like the extra cash to cover my rising mortgage interest.

    I would have a hard time forgiving Rudd if he completely scrapped the promised cuts. He’d then just be another politician who promised/lied his way to the top. But if he delivered the tax cuts as a mix of outright cuts and opt-out super contributions I think he could sell that without looking bad. He could then say he’d kept his promises while also being “fiscally conservative”.

    And who knows, if he delivers on this, maybe it’d be a sign that we can actually believe him the next time he makes a promise. Wouldn’t it be nice to have a government we could actually believe?

    Jon.

  13. Sam:

    I tend to agree with GZG. The cost of your suggestions might be extremely prohibitive, and of course, solar panels and water tanks will still need appropriate maintenance and replacement in the future, won’t they? This might push up rents.

    The cost of water to the consumer at this point in time is not particularly high.

    As for electricity, the biggest consumer is non-water power (e.g. fridges, freezers, washing machines, air-conditioners – anything with a motor).

    My household went from two people to one nearly 6 months ago.

    My hot water bill has been cut almost exactly in half, but general power has reduced very little – only about 20% – with no teenager ATTEMPTING to burn up computer power almost 24/7.

    Although your ideas are good, they are probably not economically viable, but I think people should consider putting in their own ceiling insulation. That isn’t too expensive.

    It reduced my in-house temperature by 5 degrees C in the summer.

    If you’re using fibreglass batts (not recommended by me – incredibly itchy) or wool/polyester batts, one or so leftover batts could go into the electric hot water system to stop it losing heat through the top.

    I have a Saxon 250 litre which I consider to be poorly insulated (more money for AGL, previously Energex). If I had some spare batts, in they would go.

    Another alternative might be to put an insulation blanket over the top and the sides.

    I think the foremost things in people’s minds are paying bills, mortgages, transport and food costs – items essential to living.

    Since the recent flooding in Queensland, we are told meat prices alone will rise by 20%. But will they come back down when the stranded cattle are slaughtered? My guess is “No”.

    A recent television report stated that the death rate in Australia is now higher than the birth rate, which might begin to negate concerns.

    Phil Travers:

    What an excellent post! You really have your finger on the pulse.

  14. Here’s some good news from Centrelink for a change.

    Utilities Allowance will increase to $125 a quarter for both singles and couples, and be paid in March, June, September and December.

    It will be paid to all recipients of Age Pension, Carer Payment, Disability Support Pension, Wife Pension, Widow B Pension and Bereavement Allowance.

    Telephone Allowance will increase to $33 per quarter for those on the internet. All you have to do is provide Centrelink with the name of your ISP.

    I got a letter in the mail dated 24/02/08. You can fill in their form and send it back, or fix it up on the internet.

    As a single person, I got a $36.50 State government rebate on utilities in the last quarter, so this really is a big bonus.

    It says the new Utilities Allowance will start going into bank accounts in the fortnight commencing 20 March 2008.

    Unless the State government rebate is being discontinued, I could end up well and truly AHEAD! In a worst case scenario, I may only have to pay $3 or $4 in the summer months.

    My guess is that a huge increase in electricity charges could follow.

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