ESSA

ESSA

Review of the Economics Society of Australia’s Budget Night


David Haines

By

May 13th, 2012


At the Economics Society of Australia’s annual Budget Night, Professors Neville Norman and John Freebairn provided their members (along with a strong showing of ESSA members) with an in depth budget analysis.


Budget analyses in the media consist of a scramble to tell  readers whether or not the government has kept or broken promises and above all else,  to tell us who has won and lost out of the budget, as well as who would have won and lost had the opposition been in power.

What never fails to escape the focus of the media hurricane is the extent to which this budget addresses the deeper issues facing the country as a whole and what measures are being taken now to combat the medium to long term pressures that the country faces. However at the Economics Society of Australia’s annual Budget Night, Professors Neville Norman and John Freebairn provided their members (along with a strong showing of ESSA members) with precisely that kind of analysis.

Associate Professor Neville Norman, University of Melbourne

Professor John Freebairn, University of Melbourne

 

 

 

 

 

 

 

 

Budgets : Where to Begin?

Both speakers stressed that the starting point for analysing the budget is to take a step back and define what the goals of a government are, and how these should translate through the budget. Professor Freebairn neatly summed these goals up as being a responsibility to ensure property rights and low transaction costs to enable the smooth running of the market economy, and to address the issue of equity through the provision of grants, services, health, and a progressive income taxation system.

Professor Freebairn then pointed out that rather than having low transaction costs, Australia suffers from overregulation and an oversized bureaucracy, and that equity aims have long been hampered by a highly inefficient taxation system. He gave a glaringly clear example of the tax efficiency costs that exist in Australia by comparing royalty and stamp duty revenue raising, that cost approximately 80 cents to administer for every dollar raised, with GST revenue that costs only around 10 cents to administer for every dollar raised. Unfortunately the Henry Tax Review of 2010 which recommended that inefficient taxes be scrapped in favour of simpler, fairer, and more efficient taxes, was and remains  largely ignored.

Risk that the Budget will not meet expectations

Professor Norman made the excellent observation that the budget, just like any other business modelling, is risk sensitive and therefore budget forecasts should display alternate figures for differing scenarios so as to “never hang your hat on one version of the future”. The point was made that it only takes one natural disaster or a downturn in the world economy for all the numbers in the Budget to become irrelevant.  The risk of either event occurring is far from negligible.

Furthermore the forecast surplus that Professor Norman referred to as “wafer-thin and extremely brittle”, could easily become a deficit if growth doesn’t meet expectations (Professor Norman predicted growth of 1.5% instead of the 3.25% government forecast).  A deficit could also eventuate from relatively minor shifts in revenue and/or expenditure. For example if the mining tax doesn’t raise as much as expected (many predict that it won’t), or as Professor Freebairn pointed out, if the National Broadband Network (NBN) ends up running at a loss leaving the tax payer to foot the bill.

Obviously governments are not keen to provide alternative scenarios for the budget, preferring instead to present them in the best possible light  or as best fits their strategic aims.  For example,  Treasurer  Peter Costello’s Budgets during the Howard years (1996-2007) frequently had an upside  ‘surprise’ which  allowed strategic cash handouts, to shore up electoral support, particularly in election years.

Talking Tax

In the 2012/13 Budget, much was made of raising the tax-free threshold from $6,000 to $18,200, thereby removing the need for up to one million low income earners to file tax returns.  However both Professors made the point that the actual marginal benefit to income earners, including low income earners, is much lower than these figures might suggest.

The low income tax offset (LITO) currently provides a tax rebate of $1,500 to workers earning under $30,000 dollars (the $1500 then reduces at a rate of 4% for each dollar earned over $30,000 and phases out completely for incomes above $37,500), making their effective tax-free threshold $16,000 rather than $6,000. After the government raises the tax-free threshold the LITO will be reduced to only $450 but won’t start phasing out until $37,000 at a rate of 1.5% on income earned thereafter (phases out completely at $67,000).  This means a worker on an income of $37,000 or less will have a tax-free threshold of $20,543 rather than $18,000. Therefore the change in a low income earners tax threshold is only $4,542 (20542-16000) rather than $12,200 (18200-6000).

Marginal tax rates have also increased.  Incomes between $18,201 and $37,000 (between $20,543 and $37,000 for people earning $37,000 or less) will now be taxed at 19% instead of 15%, and incomes between $37,001 and $80,001 will be charged at 32.5% instead of 30%.

Together this means that the overall benefit to wage earners is much lower than is suggested by the government’s raising of the tax threshold:

Income Earned Tax Saving Income Earned Tax Saving
$20,000 $600 $55,000 (Median income) $303
$25,000 $503 $60,000 $303
$30,000 $303 $65,000 $303
$35,000 $303 $70,000 $253
$40,000 $303 $75,000 $128
$45,000 $303 $80,000+ $3
$50,000 $303

The problem that this does not solve, except temporarily in the case of low income earners, is that whilst incomes continuously increase over time with inflation, the tax thresholds remain fixed, meaning that all workers pay more tax each year as the bulk of their incomes slowly move into higher brackets.  This is known a tax creep, or to use Professor Norman’s more theatrical description, “the strangler!”.

Addressing the Long Term Challenges Facing Australia

The Australian economy faces a host of structural challenges into the future, described by Professor Freebairn as “severe”.  Some of his examples included:

  • Massive infrastructure requirements to meet the needs of a growing Australian population; the Australian Bureau of Statistics population projections are between 30.9-42.5 million people by 2056 (currently approx. 22.9 million).
  • The aging population is increasing demand for government expenditure, particularly in the areas of health and old-age pensions, and is simultaneously diminishing the proportion of Australians generating tax revenue.
  • Australia has seen poor productivity growth in recent years, with little sign of improvement on the horizon. Currently masked by the mining boom, if not improved, low productivity could see Australia’s economic prospects rapidly deteriorate when the boom ends (if not before).
  • Potential cost blowouts and poor performance of existing infrastructure projects such as the NBN.

One strategy, raised by Professor Freebairn, to counteract these issues is to increase the efficiency with which government revenue is collected and spent, and thereby reduce individual and business compliance costs in meeting tax and regulatory obligations, as well as massively reduce the need for bureaucracy.  Examples of how to achieve this included condensing all the different individual and family benefits, all of which need to be separately administered, into one means tested payment; as well as abolishing alternate tax treatments on income, such as the discount on superannuation contributions, recommending that all income be taxed at the same rate, albeit preferably a lower one. Revisiting his point about how different taxes cost different amounts to administer, Professor Freebairn also advocated increasing the Goods and Services Tax (GST), broadening the mining tax (include more than just iron ore and coal), replacing stamp duty with an annual land tax, and implementing all of the other recommendations of the Henry Tax Review.

Controversial Claim of the Evening

Professor Norman took the prize for the most controversial claim of the evening!  He accused the RBA of creating more instability than it solves.  Stating that because the bank’s decisions are based on time-lagged economic data, it reacts too late to changes in the economy, and consequently often makes things worse. The controversy did not stop there.  He went on to announce that the interest rate should be pegged, and furthermore that the government should “not just put the rate on hold. Put the bank on hold!” Any attempt at a quick analysis of this can of worms in this article would not be giving Professor Norman the respect that he has so clearly earned over his long and illustrious career and therefore my next article will be dedicated to exploring his ideas on the RBA further.

Wrap Up

Economically, Australia finds itself in a state of political short-termism, reinforced by the media, which has resulted in people viewing the budget only in terms of what they will gain or lose in the following year. Therefore to paraphrase the ESA Victorian Branch President Dr Mathew Butlin, good tax reform can only be implemented by a powerful government with votes to lose, as tax reforms are always unpopular even with people who, through economic ignorance, fail to realise that it benefits them.  This statement holds true for any major economic reform.  It is therefore up to economists to explain good economic policy to politicians, and for politicians to actually prioritise the implementation of expert policy research such as the Henry Tax Review by being prepared to spend the time and energy to explain important reforms to the people. This is no small task in the face of a reluctant media, and opposition parties who are all too willing to build up fear campaigns to gain popular support.  This is what happened with Labor’s opposition to the GST, and in the current Opposition’s campaign against the mining tax, which together with mining lobby support, has led to a tax that is very far from the efficient broad based tax intended by the Henry Tax Review.  What’s worse is that these politically motivated fear campaigns generally come with an Opposition promise to rescind the contested policy if elected into office, although this rarely happens as evidenced by the Liberal Party not rescinding medicare and similarly Labor not rescinding the GST. The threat of rescission creates an environment of uncertainty, making businesses hesitant to invest, to the detriment of the overall economy. Politics is a dangerous game for more than just the participants.

 

Follow me on twitter @david_haines85

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

  • Lolimar

    I think of largest concern and of irony to me, was the serious lack of “vision” as Gillard likes talk about. She likes to talk up her government’s vision and slam down Abbott’s supposed lack of vision.

    Assuming that ‘vision’ is significantly related to the longer-term infrastructure spending, then we saw a lack of vision by the Gillard Government. My impression was, instead of a budget that would continue to address the lack of public transport projects in our capital cities, continue to support hospitals which also seem to be ailing, and continued support of education to ensure our workforce is skilled. It was a budget which seemed to be in the mood of handing money back to australians in various ways that sounded nice, but perhaps a minimal tax cut would’ve done that all more efficiently.

    A question though. Why are some of the efficiency measures considered politically difficult to do? It sounds like consolidating family benefits and such into once package is an incredibly sensible way of doing things for instance. Similarly that comparison of royalty and stamp duty costing 80 cents for a dollar of revenue raising would be a figure that I would imagine the public would react with concern to.

    In regards to the professor Norman’s ‘Controversial claim’ what did he mean by pegging the interest rate?

    I think the RBA faces a very difficult challenge because of this ‘two-speed’ economy idea. Changing the target cash rate is a very blunt instrument, so I’m not so sure if we should be so quick to criticise them.

    A suggestion: Consider holding debates/forums. This would be an excellent topic. It would be very interesting to put students and distinguished academics together.

  • David Haines

    Lolimar, thanks for your comment.

    You are right that there are a lot of pressing infrastructure problems that Australia needs to deal with. I personally believe that the government has plenty of room to take on debt in order to make long term investments in infrastructure. Debt in itself is not a bad thing it really depends on a country’s ability to service the interest repayments, which with debt at our levels is far from an issue.

    Jus t quickly in terms of the governments ‘cash splash’, on Inside Business this morning they were discussing the fact that the Budget could almost be considered stimulatory in some respects because it takes money from higher income earners that are liable to save it until the markets improve etc and gives it to lower to middle income earners are much more likely to spend. Interesting.

    In terms of the specific reforms you mentioned. The Henry Review recommended for Stamp Duty to be replaced by a Land Tax payable by all land owners; this tax would be broad based, would reduce wasteful uses of land and improve housing affordability, as well as probably lead to higher density living. As you can imagine this would not go down well in Australia where home ownership rates are very high. The GST should be put up and income taxes reduced however this would require a lot of explanation (as Peter Costello would know well from the first time round) and would be easily opposed by the opposition as another “big tax on everything”.

    Professor Norman only mentioned his thoughts on the RBA in passing so unfortunately I cannot be too specific until I have done further research for my next article. However I have invited Professor Norman to come and view the article and respond to any comments, so I will leave that question for him to respond to. I will say that he advocated for removing the RBA’s power to determine interest rates, and fixing the rate at a certain level. I am as yet unsure how this rate would respond to interest rates overseas, or what market mechanisms might be involved.

    In terms of criticising the RBA, it is a bold move, and probably not one that students should ‘try at home’ (at least publically anyway). However I have every confidence that Neville has some very strong arguments to support his claim, otherwise he would not have made it.

    I am glad that you have voiced your desire for a forum to be held because I happen to strongly agree that it would be a fantastic addition for our society if students were able to readily discuss issues, ideas, and events with each other. The good news is that we will be launching a new forum facility (by we, I mean the much more tech savvy members of the committee as opposed to myself) for the second semester. Should be great, really excited about it. Also we will be holding a Q & A event in week four next semester which will also be a great opportunity to engage in some economic discussion.

  • Lolimar

    “You are right that there are a lot of pressing infrastructure problems that Australia needs to deal with. I personally believe that the government has plenty of room to take on debt in order to make long term investments in infrastructure. Debt in itself is not a bad thing it really depends on a country’s ability to service the interest repayments, which with debt at our levels is far from an issue. ”

    That’s a pretty important point to make. I don’t understand why people seem to equate responsible economic management with budget surplus ALL THE TIME. Well perhaps that’s an exaggeration, but simply put, whenever a business is looking to expand or a prospective home-owner is looking to buy a home, it’s a rarity, that it doesn’t involve any debt financing. I have no qualms with consistent controlled budget deficits, providing that the money is spent efficiently. Government debt pales in significance when put next to private/household debt.

    “In terms of the specific reforms you mentioned. The Henry Review recommended for Stamp Duty to be replaced by a Land Tax payable by all land owners; this tax would be broad based, would reduce wasteful uses of land and improve housing affordability, as well as probably lead to higher density living. As you can imagine this would not go down well in Australia where home ownership rates are very high”

    First, why is stamp duty so inefficient at collecting revenue? Isn’t it quite literally the state giving the seal of approval?

    Higher density living is a contentious issue. But it’s most important that people are able to reasonably choose between the higher and lower density living. I know people who would prefer the apartment/high-rise style of living, whereas other people (myself included) like living in more quiet suburbs. But I think this could be overcome with a well designed land tax. Perhaps a tax bracket system or sorts?

    “Jus t quickly in terms of the governments ‘cash splash’, on Inside Business this morning they were discussing the fact that the Budget could almost be considered stimulatory in some respects because it takes money from higher income earners that are liable to save it until the markets improve etc and gives it to lower to middle income earners are much more likely to spend. Interesting.”

    Interesting indeed. But then it’s a problem of magnitudes. That is, even if the propensity of high income earners to spend is lower compared to lower income earners, it’s possible in absolute terms that higher income earners still spend more, and by giving the money to lower income earners you’re then reducing overall household consumption. Either way, I would imagine a tax cut of some sort would be more efficient of achieving that.

    “I am glad that you have voiced your desire for a forum to be held because I happen to strongly agree that it would be a fantastic addition for our society if students were able to readily discuss issues, ideas, and events with each other. The good news is that we will be launching a new forum facility (by we, I mean the much more tech savvy members of the committee as opposed to myself) for the second semester. Should be great, really excited about it. Also we will be holding a Q & A event in week four next semester which will also be a great opportunity to engage in some economic discussion.”

    Sounds good. Forums are awesome, in particular, the anticipation of new posts in a thread. Also much more convenient for discussions, with quoting tools and such.

  • http://www.linkedin.com/pub/dean-pagonis/1b/117/319 Dean Pagonis

    Lolimar,

    re stamp duty being inefficient:

    http://taxreview.treasury.gov.au/content/FinalReport.aspx?doc=html/publications/papers/Final_Report_Part_1/chapter_6.htm

    This is the section of Henry Tax Review that discusses this issue. I would rather link it then paraphrase since it is clearly explained there.

    David and Lolimar,

    re consistent deficits that fund infrastructure programs

    I would have to disagree – surpluses are an important part of flattening the business cycle in the good times (withdrawing public funds when enough private demand exists eg in Australia, domestic domand is at a 4-year high); having consistent deficits, even during good economic periods, means there is very little scope to respond to downturns with fiscal expansions that don’t scare away the markets as well (which will punish us with higher yields). I do take David’s point that our debt levels are much lower than other countries, but I think there are better ways to finance infrastructure spending (see below).

    I agree with the general comments surrounding the need for infrastructure spending – Dr Ken Henry mentioned last night on 7:30 Report that Australia’s population will rise by 14million by 2030, half of which will be people aged over 65. These are truly staggering numbers, which will put heavy pressure on politicians to continue to raise health and infrastructure spending to keep up. The issue is two-fold: lack of revenue coming in (150bill writedown in revenue since GFC) and too much spending in middle-class welfare in this country. Key to this is proper taxation reform, much of which is covered by Henry Tax Review (GST being an exception – I would advocate broadening the base and increasing the rate of GST going forward), and also some tough political decisions around middle class welfare payments. The chances of both of these occurring are very slim; the Howard government started the middle-class welfare payouts due to the higher-than-expected revenues from Mining Boom Mark I; and these have continued under Swan, despite lack of revenue to support it (which is why he had to fund them by scrapping the company tax cut; to his credit, means testing was introduced to some welfare). With the numbers in parliament being so tight, and an opposition seemingly too scared to spend some political capital to implement proper economic reform, I think there is little chance for proper reform. Only time will tell though.

  • Lolimar

    Thanks for the link to stamp duty.

    “I would have to disagree – surpluses are an important part of flattening the business cycle in the good times (withdrawing public funds when enough private demand exists eg in Australia, domestic domand is at a 4-year high); having consistent deficits, even during good economic periods, means there is very little scope to respond to downturns with fiscal expansions that don’t scare away the markets as well (which will punish us with higher yields). I do take David’s point that our debt levels are much lower than other countries, but I think there are better ways to finance infrastructure spending (see below).”

    The absolute figure of a surplus vs a deficit shouldn’t be nearly as important as our ability to finance the budget position. That is, suppose we were operating at a ‘small deficit’ and then were required fiscal expansion that made that larger, if we were still able to finance the deficit it shouldn’t matter much. Of course granted this is easier said than done, it would be hard to predict accurately how tax revenues change during a downturn.

    Nonetheless, government’s are in place to provide for public goods. Private investment tends to not do that well. So well targeted infrastructure spending should always be important and a separate issue to stabilising the business cycle.

    On your point about welfare spending. Budget papers show that social security and welfare expenses come to about 45% of revenue after GST. That is certainly waaaaay too large, especially when compared to spending on other areas. For example, Education makes up about 10%. So scrapping many of the welfare payments would be a good start, but the question would be then, how much could you reduce welfare spending?

  • David Haines

    Hi Dean

    Thanks for putting up the stamp duty link, Lolimar I hope that answers your query.

    Just to clarify, I was saying that the government has plenty of room to take on debt, not that it should run consistent deficits which by definition has to lead to debt spiraling to unsustainable levels. In terms of domestic demand being at a four year high, that it not particularly positive when you consider that four years ago the world was in the midst of the GFC. You are right that surpluses should be run when times are good so as to allow private demand to take over as well as to avoid crowding out business investment as well as to prepare for future shocks. I question whether we are really at that point yet? In fact with so much economic uncertainty due to Europe and fears of a slowdown in China it seems like if anything parts of the economy could use some stimulation. The good thing about starting up some infrastructure projects now is that as Dr Ken Henry said on the 7.30 interview, when stimulus is needed in a crisis you dont have time for infrastructure projects as the key thing is to “get the money out the door”. In saying that I am not talking about a massive increase in spending because Australia does have to protect its AAA rating and signal that it is a financial safe haven.

    In terms of the GST not being part of the Henry Review that is a little bit misleading because the Henry Review was specifically prohibited from reporting on GST, therefore in fairness to Dr Ken Henry I would say that he would agree with the broadening and increasing of the GST.

    Middle class welfare is indeed a massive problem, Joe Hockey made some very valid points that Australian’s have been instilled with a sense of entitlement to middle class welfare that is unsustainable (ironic in a sense because as you say the Howard Govt was largely responsible for this). However in saying that he is also part of a party that opposes means testing welfare payments which is in direct contradiction to what he was saying (although it is not clear that he personally agrees with the Opposition’s position on this).

    Whilst there are not many major reforms there are alot of small reforms that are moving in the right direction such as means testing welfare and cutting out parental payments when a child turns 6 instead of 16 years of age, in favour of a new start allowance that is conditional on parents actively looking for work.

    Perhaps it is unrealistic to expect that a minority government will have the capacity to implement major reforms? However in saying that the carbon tax got through parliament (this may have been a special case given that it was a greens party platform and therefore with their support the government had no trouble getting it through the parliament). I dare say they wouldn’t have gotten a GST increase through!

  • Lolimar

    “Thanks for putting up the stamp duty link, Lolimar I hope that answers your query. ”

    Yep it does. Yes I agree stamp duty should be replaced with an appropriate, broader land tax.

    I’ll retract the “consistent” in deficits now. That was quite silly really, ah well, got something very useful out of this discussion – won’t slip up with that in public now :P. More seriously though, the general point I support still stands. We should be maximising our expenditure (efficiently) with constraint by a reasonable debt level.

    I would like to emphasise again that, infrastructure spending (and other spending in improving the quality of public goods and services) shouldn’t be tied directly to short-term stimulus or the business cycle. It’s about long-term growth. For instance trying to counter the trend of stagnant productivity growth, and increasing the skill level of our work force. In International Trade Policy, one theme has been this idea that skilled workers tend to benefit more from free trade more than unskilled workers (and it’s possible that unskilled workers can become worse off) for a case like Australia. Thus it’s important that our workforce is skilled and to achieve this, our education needs to be top-quality.

    It would be a grave folly if we ignored a long-term growth agenda simply to ensure short-term growth and stability.

    “Middle class welfare is indeed a massive problem, Joe Hockey made some very valid points that Australian’s have been instilled with a sense of entitlement to middle class welfare that is unsustainable (ironic in a sense because as you say the Howard Govt was largely responsible for this). However in saying that he is also part of a party that opposes means testing welfare payments which is in direct contradiction to what he was saying (although it is not clear that he personally agrees with the Opposition’s position on this).”

    Not too sure here. Australians tend to be individualistic compared to most countries with us losing to pretty much only the US in this regard. Posed correctly I think means tested welfare payments and a reduction in middle class welfare is not a tremendous ask. Especially if the flip-side is the money is better-spent on public goods.

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