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The government is adamant its proposed three-stage tax package be passed in its entirety or not at all – thus potentially denying a slowing economy some much-needed stimulus. By Mike Seccombe.

Tax cuts and economic stimulus

You might think of it as a hostage situation, in Canberra.

When parliament resumes next week, the Morrison government will present a huge package of tax changes, parts of which would provide much-needed stimulus to the ailing economy, and others that analysis suggests would simply exacerbate inequality. The government has refused to split the package into its component parts, insisting the senate pass all of it, or none.

Which is to say, unless the parliament accedes to its demands for income tax cuts for the wealthy, it will deny the economy the medication it needs in order to return to good health. In essence, it is saying “pay up, or the economy gets it”.

The government is proposing to legislate personal income tax cuts, at a total cost of $158 billion over 10 years.

The first stage, worth $14 billion, would have immediate effect, benefiting low- and middle-income earners with a tax cut of up to $1080 for singles and $2160 for two-income households. The greatest benefit would go to those earning between $48,000 and $90,000, tapering to nothing for those earning above $126,000.

This measure is almost universally supported across politics, economic experts and business and welfare groups. It is seen as being an urgently needed stimulus to demand in a slowing economy, and well targeted, given all the benefit would flow to those most feeling the squeeze of stagnant wages and cost-of-living pressure.

The second stage of the proposed cuts, replacing the first and starting on July 1, 2022, is not so precise. It would cost $49 billion and see the stage one tax cuts effectively doubled for most workers. Analysis by Matt Grudnoff, senior economist at The Australia Institute, shows middle-income earners would receive 61 per cent of the benefit of stage two, while high-income taxpayers would get 26 per cent.

Although economists do have some qualms about the second stage, largely on the basis that it will have a less-stimulatory effect than the first, it seems poised to easily pass the senate. Indeed, Labor now is calling for the government to bring forward stage two, and not wait until 2022 to lift the threshold for the 37-cent tax rate from $90,000 to $120,000. Before the election, Labor had promised to repeal it.

It’s the tax package’s final stage – at $95 billion, by far the most expensive – that is the point of contention. Due to come in in 2024, it would apply a rate of 30 per cent from $45,001 all the way up to $200,000.

The government’s budget boast was that the changes would ensure 94 per cent of all taxpayers would enjoy a marginal tax rate of 30 per cent or less. Only the 6 per cent of Australians who earn above $200,000 would pay the top rate of 45 per cent. This would, in turn, encourage “hard-working” Australians to be more “aspirational”.

By Grudnoff’s calculations, a third of this final round’s benefit would flow to only the top 10 per cent of taxpayers. More than half would accrue to the top 20 per cent, while those in the bottom half of the income range would get just 12 per cent.

The government argues that when all parts of the package are taken together, it will not much change the progressive nature of the income tax system, in which high-income earners carry more of the tax burden than those on lower wages.

Calculations by Treasury, released in the budget, estimate the income tax paid by the top 10 per cent of earners would fall only slightly, from 44.6 per cent to 44.0 per cent.

Other modelling suggests the tax cut package will result in a much greater shift of the relative tax burden down the income scale. The gap may be explained by this government’s attempts to de-skill and politicise the Treasury department, according to Ross Gittins, The Sydney Morning Herald’s venerable economics editor.

“The Coalition’s politicisation of Treasury, intended to kill its corporate sense of mission and replace it with people who’d proved their right-thinking and party loyalty as ministerial staffers, sent the message that the government wanted people who spoke only when spoken to and kept any contrary opinions to themselves,” he wrote this week.

In its modelling, the Grattan Institute found the tax share paid by the top 20 per cent of income earners would decline three percentage points over 10 years. Meanwhile, the proportion paid by the middle 60 per cent of income earners would go up three points.

Grattan’s budget policy program director Danielle Wood explains the institute ran the tax changes against two widely used indexes for measuring the progressivity or otherwise of tax measures.

“Both suggest the package will make the income tax system less progressive than it has been at any point in the past 20 years. Personal income tax will be less progressive in 2024-25 than it has been for any year for which we have data, and it will become even less progressive over the remainder of the decade,” she says.

Even if one takes the more generous Treasury numbers, it still amounts to a regressive change at a time when inequality in Australia is rising.

Beyond the issue of equity, there also is the matter of timing. To put it mildly, the Australian economy is looking weak.

During the past five years, wages have been stagnant, even as unemployment remained reasonably low by historical standards. Consumer spending remained robust in the early part of that period, but the past couple of years has seen a steep decline in house values which, says Chris Richardson, a partner at Deloitte Access Economics, “has made people much more careful about spending, because they’re feeling less wealthy”.

This has inevitably had an effect on the broader economy. Indeed, the surprise is that it didn’t happen sooner. During the past year, GDP growth has plunged from 3.2 per cent to 1.8 and is continuing downwards. In the past two quarters, the country has entered what is being termed a “per capita recession”, meaning that while GDP grew, it grew at a slower rate than the population.

Yet some indicators have remained strong. Even as wages flatlined, labour productivity grew at around its 30-year average. Corporate profits have been strong, rising over the past couple of years about eight times the wage rate.

“Another key measure of how well the economy is doing – national income growth – is actually bang on its decade average,” says Richardson.

“A chunk is coming as mining profits, so Mr and Mrs Suburbs aren’t necessarily feeling it… Earnings from exports in general are up over 60 per cent over the past three years.”

The Morrison government, having downplayed the economic malaise before the election, has lately acknowledged it, but sought to blame factors beyond its control, including drought and problems in the global economy.

The prime minister is right about the drought, says Richardson, but not about the impact of global forces.

The beggar-thy-neighbour mercantilism of the Trump administration is playing havoc with international trade and confidence but “while the world [economy] may be weaker … China’s construction is going gangbusters, so coal and iron ore prices are way up,” says Richardson. “The reason is, as China slows, it throws money at stimulus.”

Richardson says he is more optimistic than most that economic stimulus in various forms – interest rate cuts, loosened standards for home lending, some of the tax cuts, a lower dollar, better weather – will see things pick up.

Other economists are concerned that we are now seeing the beginning of what Ross Gittins recently characterised as a “vicious circle [whereby] private consumption and business investment can’t grow strongly because there’s no growth in real wages, but real wages will stay weak until stronger growth in consumption and investment gets them moving”.

At the heart of the problem is the simple reality that Australian business has failed –refused, actually – to share the benefits of growth with its workforce. And the workers, deprived of bargaining power by structural changes including the decline of unions and increasing casualisation, have been too cowed to demand pay rises, or to change jobs. And now business is beginning to reap the consequences of its actions in suppressing wages.

Thus, we have seen repeated calls during the past two years from the governor of the Reserve Bank, Dr Philip Lowe, for employees to demand substantial pay rises, and for employers to give them. To date, about the only people paying any heed to these calls is the Fair Work Commission, which has increased the wages of the lowest-paid workers at a rate greater than both inflation and the average wage in each of the past three years.

The RBA has been doing what it can to get the economy moving. In August 2016 it reduced the official interest rate, the cash rate, to a historically low 1.5 per cent. Yet unemployment, a tick over 5 per cent, shows signs of moving up again, and underemployment – people in work but working less than they would like – remains stubbornly high at more than 8 per cent.

This month the RBA cut rates further, to 1.25, and Lowe last week suggested another cut was likely.

“The most recent data – including the GDP and labour market data – do not suggest we are making any inroads into the economy’s spare capacity,” he said. “Given this, the possibility of lower interest rates remains on the table. It is not unrealistic to expect a further reduction in the cash rate as the board seeks to wind back spare capacity in the economy and deliver inflation outcomes in line with the medium-term target.”

He also warned there is not much room for the RBA to do more.

“It is important though to recognise that monetary policy is not the only option, and there are limitations to what can be achieved. As a country we should also be looking at other ways to get closer to full employment,” he said. “One option is fiscal policy, including through spending on infrastructure. Another is structural policies that support firms expanding, investing, innovating and employing people.”

Lowe subsequently suggested government should “have their top drawers full of really good ideas that are shovel-ready” in case emergency stimulus is needed to respond to further slowing of the economy.

But much is already being done, infrastructure-wise, as Peter Colacino, executive director of policy and research at Infrastructure Australia, tells The Saturday Paper.

“The federal government and state and territory governments are spending considerably on infrastructure at the moment, to such a point that some people have suggested the market in some places, particularly Sydney and Melbourne, is bordering on being overheated.

“Since 2015, over $123 billion of infrastructure projects has commenced, and there’s a forward pipeline of over $200 billion of committed projects.”

Colacino insists there remains scope for more, emphasising the need for more transport infrastructure.

But any project must be well targeted if it is to produce much-needed economic returns. It is Infrastructure Australia’s job to make those assessments. And while Colacino didn’t want to talk about it, the Grattan Institute’s analysis found only two projects in this year’s federal budget had their business case approved by IA. Half of the projects announced were not on the regulator’s priority list at all. The evidence suggests political benefit was the government’s primary consideration; election funding announcements flowing overwhelmingly to marginal seats.

The other problem is that there is a lag time between the decision to go ahead with big infrastructure projects and the realisation of their economic benefits.

In the case of economic emergency, says Wayne Swan, who was Australia’s treasurer during the global financial crisis, the first response should simply be to give money to people who will then spend it.

“The best stimulus is one that goes to cash-constrained consumers. The sooner you get a bit of stimulus out there, the better.”

The Rudd government’s response to the GFC, attributed to Treasury secretary Ken Henry, was succinct: “Go early, go hard and go households.”

The initial action, in October 2008, was a $10.4 billion stimulus package, around 1 per cent of GDP at the time, which included $8.7 billion for pensioners and low-income families in the form of cash bonuses.

It was followed by a big infrastructure package – $14.7 billion for schools, $6.6 billion on social and defence housing, $3.9 billion on the pink batts initiative and $890 million on road, rail and other community infrastructure.

Importantly, the measures taken were temporary, unlike tax cuts, which, once enacted, tend to be hard to repeal.

Swan sees the first stage of the current government’s proposed tax package as stimulus akin to what he did during the GFC. Danielle Wood agrees.

“They come as a tax offset, targeted at people earning less than $125,000. It is essentially the same [as the GFC cash handouts], except instead of a cheque in the mail, it is a credit into your bank account,” she says.

The further down the income scale stimulus is injected, the greater the multiplier effect tends to be, because lower-income households spend more of it. Wealthier people are more inclined to save these handouts or, as Grudnoff says, spend it in ways that have less impact.

“Lower-income people are more likely to spend locally – what economists call a ‘lower marginal propensity to import’ – which is to say they are less likely to buy imported stuff. And if you take your stimulus and spend it on a trip to Europe, that doesn’t stimulate the Australian economy. It stimulates the European economy.”

“In terms of multipliers,” Richardson says, “spending beats tax. If you wanted fairness, you wouldn’t do it through tax. You’d do it through things like raising unemployment benefits. Treasury has long since made it clear that spending is the way to get fairness; tax is the way to get prosperity.”

Swan suggests the Coalition is not interested in fairness, and that it has refused to split the package because it knows the third stage would not get through the parliament, if presented as a standalone measure.

“So, they’re saying it’s all or nothing because they want to give tax cuts to the people they think they are there to represent, which is the top 10 per cent or so of income earners,” he says. “It is outrageous. There is no economic argument for the top-end tax cuts on the basis of where the economy is now.”

Many economists are inclined to agree, if in less robust language. They question the need for the third-stage tax cuts, or at least the need to legislate them now, given they will not happen for five years and may yet prove unaffordable, given the vagaries of the economic climate.

But the government is not about to give up its hostage. And Senator Rex Patrick tells The Saturday Paper that he and his Centre Alliance colleague, Stirling Griff, whose crossbench votes are crucial, are preparing to wave the whole package through.

Given the government’s refusal to split the bill, he sees no alternative.

“We’ve been getting the same from independent economists and even those that reject the idea that stage three should be included in the package pretty much unanimously endorse the need for the early stages,” he says.

“We don’t want to reject stages one and two, but we’re not comfortable with stage three. But they say they won’t split it, so we would just be wasting our time to just focus on stages one and two. Hence the reason we’re trying to work with them on a way forward to get all three.”

Patrick and Griff aren’t handing over their votes for nothing. They have been negotiating with the government for tougher measures to lower power prices by preventing gas companies from price gouging.

Patrick notes also that given the long lead time – there will likely be two elections before stage three happens – there is “time for alterations in the future by a responsible government”.

Well, maybe, although Labor, in the wake of the election, is looking decidedly gun-shy about trying to inject greater fairness into the system.

This article was first published in the print edition of The Saturday Paper on Jun 29, 2019 as "Stage frights". Subscribe here.

Mike Seccombe
is The Saturday Paper’s national correspondent.