China’s share plunge shatters Joe Hockey’s tax reform plan
Joe Hockey has a habit of making headline-grabbing speeches that come back to haunt him.
Just as he declared in London three years ago that the age of entitlement was over, so too was he planning to use a speech this week to trumpet the government’s passion for tax cuts.
“A fair dinkum government should encourage work, ideas, having a go,” the treasurer said in the speech, which was dropped to Monday newspapers to generate maximum interest.
“A fair dinkum government must do all it can to support stronger growth so, when the new day dawns, society is stronger. That’s why our forthcoming options paper on tax reform will include options for cutting personal income tax.”
If that sounds like a man with a “fair dinkum” plan, albeit one that is devoid of any detail and raises more questions than it answers, international events were already in motion that could complicate it further.
Even as Hockey delivered the speech to tax experts and chartered accountants, Chinese sharemarkets were plunging in a “Black Monday” selloff, which rapidly infected other markets, including the Australian stock exchange.
Economists and traders are still debating the causes and effects, but the markets turmoil has focused attention on the slowing of China’s economic growth. That, in turn, has raised questions about the state of the global economy, given China accounts for about half of global growth.
“There’s a concern and realisation that all is not well in China,” says Andrew Stoeckel, a visiting fellow at the Centre for Applied Macroeconomic Analysis at the ANU’s Crawford School.
“Chinese economic growth has been slowing and is most likely much slower than what has been officially recorded, at 7 per cent. China’s economy was always going to slow. That’s been known for some time: as you mature, you grow slower.
“The trouble is, these things are never smooth. There’s been a realisation in the markets that maybe things aren’t as healthy in China as we hitherto thought, triggering the selloff.”
After rising more than 150 per cent in the year to mid-June, the Chinese sharemarket has since crashed by more than 40 per cent, despite official attempts to shore it up. It plunged 8.5 per cent on Monday and dropped again in the following days.
The turmoil on global markets throughout the week had some commentators reaching for comparisons to the events that triggered the Asian Financial Crisis in 1997 and the Global Financial Crisis of 2008, but politicians and business leaders urged calm.
Speaking from the Indigenous community of Bamaga, on the tip of Cape York, on Wednesday, Prime Minister Tony Abbott blamed “over-exuberance in the Chinese market earlier in the year and the inevitable correction and slowdown in the Chinese economy”. In a market economy, he said, markets go down as well as up.
Labor was on a rare unity ticket with the government. Shadow Treasurer Chris Bowen said it was important to reassure people that the market gyrations did not necessarily flow through to the Australian economy. “The biggest risk to Australia here is a contagion of confidence,” he said.
The optimists, Hockey among them, point to a strong economy in the United States and the fact that even slower growth from China is still significant, given the sheer size of its economy. The pessimists mention a recession in Russia and Brazil, and trouble in other economies, including Venezuela and the Ukraine. “A lot of these economies are small of themselves, but there’s a large number of them which have all slowed,” says Stoeckel.
Hockey said the fundamentals, in both Australia and China, were strong. One of China’s most senior economic figures had assured him just last week “that China would use whatever tools it has available to make sure that it grows relatively strongly this year”. There was no crisis, said Hockey, just a market correction.
A widely held view is that the chain of events that led to the markets chaos began with the devaluation of the Chinese yuan on August 11, by about 4 per cent against the US dollar. This unleashed angst that the Chinese authorities were trying to stimulate a sluggish economy by cheapening the currency.
Concerns about slowing growth in China were compounded by a weak manufacturing index published there last week. Investors were also rattled by the failed attempts of Chinese authorities to manage the sharemarket declines.
This is the narrative that has taken hold among many commentators, but Saul Eslake, former chief economist for ANZ and Bank of America Merrill Lynch Australia, thinks the panic selling in the markets is based on a misunderstanding of what is going on in China.
“I don’t think the Chinese have the slightest intention of engineering a big devaluation of the yuan,” he says. “To the extent that the turmoil in global markets is based on a fear that’s what they’re going to do, it’s almost entirely misplaced.”
He explains that what actually happened on August 11 was not in fact an intervention by the People’s Bank of China to deliberately devalue the yuan, but rather the byproduct of a move to a more market-oriented method for setting its exchange rate.
Rather than pegging the opening point for a day’s trading on the yuan to bids from state-owned banks, which could be manipulated, the PBOC announced that day it would shift to using the end point from the previous day’s trading. It had closed lower, so it started lower.
“It was actually a step towards allowing a greater role for market forces in setting the exchange rate,” says Eslake. “That’s something Western governments have been urging on China for yonks … The fears China is about to have a hard landing very soon, I think, are exaggerated.”
Nevertheless, there are implications for Australia, as the government’s export credit agency, Efic, observed in a bulletin this week: “Whatever the reason [for the devaluation], the weaker renminbi will reduce Chinese demand for imports, posing risks to economies that rely heavily on China, including Australia.”
Also, markets have minds of their own and once a perception takes hold, it can become reality. There are some elements of modern share trading that can amplify perceptions of risk and rapidly reinforce them.
This week’s events have raised questions about whether high-frequency and algorithmic trading systems had exacerbated the volatility, particularly in the US but also in Australia. These trading systems use computer-generated formulas to try to beat the market, but in the process can also shift it, setting off a spiral.
Eslake believes another factor in the selloff that has been underplayed is the increasing signs that the US Federal Reserve is preparing to lift interest rates. This has implications for equity markets after almost seven years of zero interest rates, which encouraged investment in riskier assets and led to capital flowing into China and other emerging markets.
“If the Fed is going to start the move away from zero interest rates, not that I think they’re going to do it in a hurry, it is a pretty portentous move and one that should have been taken on board by sharemarkets around the world more than it has been.”
Eslake is more upbeat than some about China’s prospects, but the slowdown in the world’s second-largest economy has long been apparent. The question is not if its growth rate is slowing, but rather by how much. From Australia’s perspective, the steep drop in the iron ore price in the past 18 months has been the clearest sign of this, even though export volumes remain high.
Indeed, for years there have been warnings that Australia will feel the impact of the waning of the China-driven resources boom.
In September 2012, former Hawke government economist Ross Garnaut cautioned: “I think we’re going to have a very difficult time adapting to the decline in living standards that’s going to be a necessary part of the adjustment to the end of phase one and two of the boom”.
The problem, Garnaut told a conference at the time, was of particular concern because governments did not do enough to save the proceeds from the mining boom, which took off in 2003, to carry economies through less lucrative periods.
This is the backdrop to Hockey’s pledge now to cut income tax at some point. No one can see how he hopes to pay for it, especially if he still wants to hold on to his other promise, to return the budget to surplus. And that’s even before you contemplate the possibility of a sharp global economic downturn, a possibility this government seems loath to acknowledge.
The issue for Australia, says Stoeckel, is that “people may have set their expectations on good times rolling on, on there being plenty of money for things such as healthcare, childcare, and now that’s not there. Now you either realise that we’re in for a very flat sort of period, or you try to replace that lost prosperity through another mechanism. That mechanism, of course, is productivity. The trouble is – and this is a global phenomenon – productivity is in long-term decline.”
It’s a theme that dominated the National Reform Summit held on Wednesday by The Australian and The Australian Financial Review, where former treasury chief Martin Parkinson dispatched some difficult truths, warning that Australia was “sleepwalking into a real mess” and that “repetition of slogans is not a substitute for policy action”.
In his speech on Monday, Hockey offered up one thought bubble for tackling the productivity challenge, arguing that income tax cuts would generate growth and jobs. He attacked the “stealth tax” of bracket creep, which occurs when inflation pushes workers into a higher tax rate. Hockey argued this penalises effort, but the reality is that bracket creep means that, even without securing a promotion or real pay rise, workers end up paying higher taxes.
This “stealth tax” is underwriting the government’s budget this year, accounting for about 80 per cent of the projected rise in revenue, worth about $25 billion over four years. Alan Kohler pulled no punches in a Business Spectator column, titled “Hockey’s tax speech was truly awful”, arguing it was “a mess of muddled thoughts and contradictions”.
Eslake has sympathy with Hockey’s arguments against bracket creep, adding that it creates incentives for tax avoidance.
However, he believes the government has shot itself in the foot by already ruling out changes to the taxation of capital gains, superannuation earnings and company trusts that could be used to offset reductions in income tax.
“What our tax system does is it says: if you earn more than $180,000 through wages and interest, the government takes half. But if you earn it through capital gains, or rents or superannuation savings, then the government takes a lot less. I think it’s fundamentally unfair. It would be far better if, for example, the top rate was 40 per cent but you actually paid 40 per cent on all income above that rate.”
Hockey seemed somewhat taken aback at the criticism of his speech, which came not just from Kohler but also from Alex Malley, the chief executive of accountancy body CPA Australia, who described the speech as “long on rhetoric and short on substance”.
The treasurer urged commentators to calm down and allow the discussion over tax reform, including with state governments, to unfold.
Pre-empting this discussion somewhat, he’s talking up the prospect of income tax cuts. The problem is that this government may lack both the revenue and the political capital to persuade voters it can deliver on its rhetoric.
This article was first published in the print edition of The Saturday Paper on Aug 29, 2015 as "China shatters Hockey’s tax plan". Subscribe here.