The reality behind Morrison’s tax cuts
It was not a lie. Not yet, at least. At this point Scott Morrison’s one-word answer in federal parliament, given last week, might be more properly characterised as a semantic evasion.
He was facing questions about the consequences of the government’s tax cuts for higher income earners.
“What programs and services will be cut to fund stage three of the government’s tax scheme?” asked the opposition leader, Anthony Albanese.
“None,” said the prime minister.
But that depends on what you mean by the word “cut”.
Take health spending, for example. Historically, the amount spent by the federal government has grown by 2.7 per cent a year, for several reasons. For one, the population is growing, by about 1.6 to 1.8 per cent a year. For another, Australians are getting older – the median age has increased by almost three years over the past two decades and the fastest-growing cohort is people over 85, older people who use more health services. Medical advances such as new drugs and technologies and services also come at a cost.
At the same time, Australians are picking up an increasing share of the cost of their healthcare themselves. The cost of private health insurance has long grown faster than general inflation and faster than wages. Out-of-pocket expenses have grown and are now some of the highest among developed countries, accounting for an average of 3 per cent of household expenditure.
Yet the government is banking on cutting the rate of growth in health spending by nearly three-quarters, from 2.7 to 0.7 per cent a year.
Go to the detail of the budget papers, says Dr Stephen Duckett, health program director at the Grattan Institute and former secretary of the Department of Health, and you see much of this curtailing of growth is predicated on making huge savings on pharmaceuticals.
During the next five years, a number of widely used and expensive drugs will come off patent, allowing for the substitution of cheaper generics.
“But also, over the next five years,” says Duckett, “we are going to see a lot of new drugs come onto the market, particularly genomic drugs … which are very, very expensive. I doubt they have taken this into account. And I doubt they will make the savings.”
If the government does push on with its health saving plan, it will be by denying sick Australians the benefit of medical advances.
Is that a cut? Maybe not, if seen purely in expenditure terms. The amount spent will go up. But the amount spent per person will go down, even as the need for health services increases. And this will have consequences for the universality of a healthcare system that was once the envy of the world.
There is an unshakeable article of faith held by Scott Morrison and his ilk in a great force for which there is no empirical evidence. This faith is in the benefit of trickle-down economics.
The theory goes that if governments cut taxes on business and the wealthy, they will invest that extra money in productive enterprise, which will in turn generate jobs and growth, which will ultimately maximise both the return on endeavour and government revenue.
The original proponent of the idea, a conservative economist named Arthur Laffer, famously sketched it out on a paper serviette while dining with two rising stars of the United States Republican Party, Dick Cheney and Donald Rumsfeld, in a Washington, DC, restaurant in November 1974.
There was a germ of logic to it – if the rate of tax is zero, the government gets no money, and if the tax rate is 100 per cent, the government gets no money either, because no one bothers to work. The trick is in finding the optimal tax level between those extremes.
On the strength of that napkin, Laffer became an adviser to President Ronald Reagan, who proceeded to dramatically cut the top rates of tax. Revenues crashed, the deficit doubled and government debt tripled.
Despite this, and subsequent failures, the wealthy and tax-averse, and their political surrogates, have continued to use the theory to push for ever-lower taxes. And Laffer himself is still doing the rounds. In 2015, the year Scott Morrison became treasurer, the Australian Chamber of Commerce and Industry brought Laffer to Australia to argue the case for lower business taxes. He met with various members of the government, and was photographed with a beaming future treasurer, Josh Frydenberg. He also went on RN Breakfast, where he insisted: “All taxes are bad, Fran.”
There is a huge body of evidence to suggest the trickle-down theory does not work in practice. A major study by the non-partisan US Congressional Research Service set out to establish whether there was any correlation between the tax rates paid by high-income earners and economic growth. It ran the data over 65 years and found none. Such cuts, it determined, were associated with “increasing concentration of income at the top of the income distribution”.
Given the theory does not stimulate economic growth as promised, it follows that trickle-down does not produce the forecast tax revenue for government. This in turn leads to one of two outcomes – government must either cut programs and services, or fund them by increasing debt. Or a combination of the two.
This is a pattern we see repeatedly across countries in the 40-odd years since trickle-down theories have been applied – increased inequality, reduced government services and/or increased government debt.
For a real-time example, look across the Pacific. Donald Trump’s America seems, on the surface, to be motoring along nicely, since the president effectively halved the rate of corporate tax almost two years ago.
But look more closely. The corporate tax cuts he gave last year overwhelmingly went to share buybacks and into the pockets of the wealthiest Americans. A recent report by the Congressional Research Service found gross domestic product growth was no higher after the tax cuts than it was before. The growth in workers’ wages was marginal and lower than that of GDP. And US government debt has ballooned more than $US2 trillion in the first two years of the Trump administration.
It should be noted that under his predecessor, Barack Obama, government debt nearly doubled, from $US10.6 trillion to $US20 trillion over eight years. However, the Obama administration had to deal with the global financial crisis, expensive inherited wars and the legacy of previous trickle-down tax policy going all the way back to Reagan. Trump inherited an economy in good shape.
Meanwhile, Trump’s proposed 2020 budget would, in the words of the Los Angeles Times, “eviscerate” America’s already scant social safety net.
Before he was elected, Trump specifically promised there would be “no cuts to Social Security, Medicare or Medicaid”. The Times detailed “huge cuts” contained in the Trump budget proposal, including reductions in “Social Security, Medicare and Medicaid … food stamps, housing assistance and family assistance”.
If the Morrison government is to be believed, it will simultaneously reduce taxes, reduce government debt by surplus budgeting and reduce the size of the government relative to the overall economy. All while maintaining government programs and services. There will be no cuts. None.
This relies on classic trickle-down theory and some implausible assumptions about its capacity to stimulate the Australian economy.
The budget plan is to reduce government outlays from the current level of 24.9 per cent of GDP to 23.6 over 10 years. While this may not sound like much, it will involve an unprecedented austerity in government spending.
“Typically,” says Grattan chief executive John Daley, “government expenses tend to grow more or less in line with the economy – a bit faster when the economy is growing slower, and slower when the economy is growing quickly.”
During the past 40 years, through the tenures of prime ministers Fraser, Hawke, Keating, Howard, Rudd and Gillard, federal government spending has grown yearly by about 3.5 to 3.8 per cent on average.
But since the election of the Abbott government in 2013, that growth has declined sharply, to 2.6 per cent. And on the numbers in the 2019 budget, it would fall further, to 1.8 per cent.
The government sees this decline – largely achieved on the backs of lower income Australians – as a great achievement. The budget papers boast: “Spending growth under this Government has been the lowest of any government in 50 years – tightening eligibility and freezing indexation contributed to lower growth over much of the past decade and is forecast to halve in the years ahead.”
According to Grattan’s budget policy director, Danielle Wood, those government projections rely on there being essentially no new spending.
“That means no real per-person spending [increase] for a decade,” she says. “That particularly bites in areas like health, where there is always pressure for spending to grow faster. It means they didn’t factor in things like changes to pension deeming rates – which they are now talking about. It means no increase in Newstart, for example. If you want to keep to these projections, you can’t offer those things.”
People who are out of work and on the Newstart allowance have not seen a real increase in their payment for 25 years. Their benefits have not actually been cut, but over that time their standard of living has gone dramatically backwards as the cost of living has increased. Under the government’s plan, this will continue. As Richard Denniss, chief economist at The Australia Institute, says: “The easiest and least visible way for the government to cut spending is to let inflation do the harm on the spending side.”
Even so, says Wood, “to think you can keep that level of fiscal restraint for almost a decade is incredibly optimistic”.
Already we have seen that optimism challenged by the recent cuts to interest rates, and the effect on the incomes of pensioners. The government factors in a notional rate of return on the income pensioners earn from their savings when it calculates their pension payments – the so-called deeming rate. But the sharp fall in interest rates means they earn less than they are deemed to earn.
It’s estimated that adjusting the deeming rate to fully account for the consequences of lower interest rates will cost $1 billion. The government will likely make this change because, unlike Newstart recipients, pensioners are a vital voting demographic. Within a couple of months of the government delivering its plan for a decade of austere spending, though, a large hole has already been blown in it by an unanticipated cost. And deeming rates could well prove to be the least of the problems for the plan.
The tax cuts legislated last week are estimated to cost some $300 billion over the decade to 2029-30. In order to afford them, as well as to reduce debt, the government is relying on very optimistic forecasts for economic growth. Real GDP is forecast to grow 2.75 per cent in 2019-20. Yet growth in the year to March was 1.8 per cent, and the indications are the economy is continuing to weaken.
Likewise, the government’s projections for wage growth – given that real wages have essentially flatlined for the past six years – are very optimistic. It is forecast to accelerate dramatically, from 1.9 to 3.5 per cent over the next two years.
“These are heroic assumptions,” says Denniss. “The Reserve Bank is clearly acting as if those growth forecasts are unlikely.”
There are other heroic assumptions, too. Productivity is forecast to grow at a rate substantially above that of the past decade. Spending on welfare is expected to decline, despite the fact unemployment looks to be increasing again.
The bottom line, says Wood, is that the government will likely have to slash spending growth below even the 1.8 per cent it forecast. “That is the absolute best-case scenario. More realistically it will be 1.3,” she says.
These may seem like small variations, but Australia Institute senior economist Matt Grudnoff points out they compound over time. “The further out you go, the more it works like compound interest,” he says.
If the government’s projections work out, says Grudnoff, “by the time they get to stage three [of the tax cuts] in five years’ time, then, yes, we can absorb their cost and still run a surplus.
“But if the assumptions are out by just a small amount, then the compounding works in reverse and revenue drops substantially, and suddenly I don’t have a surplus, but I still have tax cuts legislated.
“Then what happens? If it’s the Coalition government, they’ll blame spending and they’ll start cutting.”
As things now stand, the government is already slashing some areas of spending. Housing and community services, for example, was cut by an average 11.7 per cent a year between 2014 and 2018, according to Grattan calculations. The plan is to reduce it by another 4.5 per cent a year out to 2023. No wonder the rate of homelessness is rising fast.
Richard Denniss has no doubt about the government’s real motivation, and it is not about generating budget surplus. He calls it the “right-wing ratchet” – giving tax cuts to the wealthy on the promise they will be affordable and will trickle down to benefit all, then, when they prove unaffordable, cutting spending.
“There’s no other reason to legislate those cuts now,” says Denniss. “They clearly have a long-term plan. They are setting their wealthy friends for a big pay rise.” Denniss says it doesn’t matter that the final tranche of tax cuts won’t come into force until 2024: “These people can be patient, because the rich can afford to wait.”
John Daley is more circumspect in his language. “By definition, government will do less. People will have to do more for themselves. That probably leads to less equal outcomes than would have occurred otherwise.”
As for the claim that lower taxes inevitably lead to higher economic growth, Daley makes two points. First, that Australia already is a relatively lowly taxed country, compared with other advanced economies. Second, many high-taxing countries are doing well.
“There are plenty of countries, particularly Scandinavian countries, in which the government is a much larger proportion of the economy, that seem to be doing fine for economic growth,” he adds.
“Ultimately, it depends on what kind of society you want to have.”
Historically, Australia saw itself as an egalitarian society. It’s not a descriptor you hear from Scott Morrison and those around him, who prefer the word “aspirational”.
As to what they mean by that, the answer lies in the consequences of their economic plan. It means a less progressive system, and a lower tax burden on the wealthiest 20 per cent of taxpayers, an increased burden on everyone else and, in all likelihood, cuts to government services and programs.
It means a meaner and less equal society.
This article was first published in the print edition of The Saturday Paper on Jul 13, 2019 as "The reality behind Morrison’s tax cuts". Subscribe here.