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.