The fiscal policy response to the crisis

With the effective nationalisation of the banking system now accepted as necessary (Australia’s comprehensive guarantees amount to public assumption of the risks of ownership, and hopefully the fees to be paid by the banks will reflect this) attention has turned to the role of fiscal policy.

Getting fiscal policy right involves a delicate balancing act. On the one hand, there is the short-term need for stimulus. On the other hand, the combination of a large stimulus and a bailout/nationalisation package imply big deficits, which will have to be recouped in the future.

In the Australian context, the Opposition is calling for an immediate pension increase and the bringing forward of the next stage of tax cuts. That’s a plausible line, although other opportunities for stimulus through public expenditure need to be explored. But the obvious, though unstated, quid pro quo is that the ‘aspirational’ tax cuts proposed for the next Parliament should be taken off the table. It will take a long time to restore the budget balance after the kind of stimulus that is needed here.

A further implication of the crisis is that the idea of giving big tax incentives to high income earners, in the hope that this will stimulate productive innovation, has been discredited once again. The smart rich have already cashed in, and the average punter (along with those among the rich who hung on too long) has been left with the tab. Taxing the income gains of the top 10 per cent over recent decades will provide more than enough revenue to pay for the bailout in the long term.

For some rough arithmetic on this (applicable to the global situation, though the likely impact will be smaller for Australia), let’s suppose that the bailout and stimulus cost 15 per cent of GDP. The share of pretax national income going to the top 10 per cent has increased by at least 5 percentage points and probably more, so taxing away half of that would raise 2.5 per cent of GDP or enough to recoup the cost (including interest) in 6-10 years.

23 thoughts on “The fiscal policy response to the crisis

  1. JQ,

    Could you be a little more specific? Roughly what are your proposed new tax rates and at what level would they kick in?

  2. How about no bailout and a tax break for all businesses via a cut in the corporate tax rate? That would also encourage a lot of inbound investment negating the need for debt in many instances.

    Or if you really want to incentivate some activity how about lifting the tax free threshold to $20000 pa. The LITO makes it effectively $14000 at the moment.

    Or else we could get serious about reforming the structure of the tax system and abolish state payroll taxes.

    Concern about revenue falling is over rated (when has it ever happened anyway). Simply hold government spending per capita fixed in real terms and the mildest of growth rates will still deliver loads of tax cut opportunities.

  3. ‘there is the short-term need for stimulus’. With the Melbourne Cup approaching perhaps the jockey could put away the whip and re-balance the horse. Instead of a return to unsustainable activity patterns a period of adjustment could set the scene for the longer term. For example large numbers of people in retail, financial services and resource extraction could be retrained for green collar jobs. If the stimulus is short lasting and the budget surplus is squandered there may not be another chance to get it right.

  4. Perhaps my moniker “Krugman of the Antipodes” is now deserving of a higher rank in your testimonial order of merit!

  5. Throughout Eisenhower’s presidency, the top tax rate on income over $400,000 stood at 91 percent.

    So let’s have some vision and courage, and make those on the top share the pain proportionally. $400K a year is still fair bit of incentive to get out of bed and do stuff. It is the large middle class that keeps the consumer based economy going.

  6. I think John is grossly overestimating the likely cost of the crisis to the Australian economy.

    To date a grand total of zero Australian banks have gone bust and I see no compelling evidence that will change.

    The slower economy (remember we still aren’t in a recession) might shave, say, $5 billion a year off the surplus this year and next.

    That leaves a surplus of around $15 billion – use say $10 billion in short-term aid to pensioners, the unemployed and lower-income workers and $5 billion to bring forward infrastructure spending.

    We can do all that and keep the budget more or less in balance – hell we can probably even give small tax cuts to adjust tax rates for inflation.

  7. Damocles, I was a bit unclear in my last para. I had switched my focus back to global averages. I’ve tried to clarify this.

  8. The stimulus package reinflates the first home owner’s grant to $14k; and, the RBA may cut rates again very soon. Is the debt-driven property market *really* the right place to stimulate as rates go down again? I think not.

  9. For countercyclical spending, the best way is to find things with that don’t lock you in to future spending. That makes it easy to tighten things up when you later need to.

    That suggests that you give pensioners, etc big one-off bonuses. As social policy it’s not as good as a permanent pension rise (let alone other better-targeted uses of the money) but it’s much better budgetary policy. The Keating government, IIRC, did just this in the 1992 recession. The analogue on the tax side is a one-off rebate or a tax holiday.

    The same reasoning suggests that a lot of the extra spending should go on infrastructure. We should reexamine some old options (Sydney-Melbourne VFT, a fast rail freight network, a second Sydney airport, sundry dams, bridges and alternative power plants, really good broadband, etc) because we can settle for a much lower IRR than in recent years.

  10. derrida derider: That suggests that you give pensioners, etc big one-off bonuses. As social policy it’s not as good as a permanent pension rise (let alone other better-targeted uses of the money) but it’s much better budgetary policy. The Keating government, IIRC, did just this in the 1992 recession. The analogue on the tax side is a one-off rebate or a tax holiday.

    Could this logic be a justification for the bringing forward of next year’s tax cuts, as proposed by the Opposition, given that they are planned to happen anyway? It would seem that this would act as a nice compromise between a one-off hit, and a perpetual payment.

    The concern I have is with the targeting of stimulus towards homebuyers. It’s clear that the Government is concerned by a potential popping of the housing bubble, but I’d argue (as Donal Oats said above) that the solution is not to keep pumping air into it. I suppose this is tempered somewhat by the temporary nature of this plan, given that it expires in June next year.


  11. As of tonight, Kevin Rudd has announced a $10 billion stimulus package. Events have certainly moved fast. Interest rates were rising only a month or two ago (approx.) Now they have been dropped 1% by the reserve and a $10 billion stimulus package announced.

    JQ, is there any danger of stoking goods and services inflation further? I can see assets deflating but what about food, energy, petrol, general groceries, insurance, school fees etc. Could those kinds of things keep inflating in this new environment?

  12. The stimulus package that the federal government has proposed seems like a vain attempt to prop up over inflated assets like housing. In the long run all it may end up achieving is a Japanese style lost decade where the asset prices slowly deflate. The US on the other hand may recover much more quickly because the debt has worked its way out of the system much sooner.

    It would have been a better idea to target the stimulus package at the other big problem… global warming. I’ve recently read accounts that this is exactly what the Obama camp is planning.

  13. Donald Oats, the first home-buyer’s grant is a waste of money, essentially nothing more than a government subsidy for the real estate industry.

    The only reason I can see for increasing it is that the government is scared that the Aus property market will burst, so they are trying to help prop it up. Either way, it is dumb to use taxpayer’s money propping up inflated asset prices.

  14. I agree with Donald Oats that debt-driven housing is the wrong place for stimulus, and with Smiley that global warming spends would have been better.
    Furthermore the timing is wrong, peoples needs – say food or homeless shelters or policing- will be greater in a few years when already committed economic activity and boom price and volume of term commodity contracts wind down. It is good that some of the handouts are on-offs.

    It seems morally irresponsible to encourage first home ownership -debt funded largely- when there is massive global deleveraging.

    The choice of infrastructure spends will be rushed and suboptimal because of the limited time available to lift the quality of the original cost/benefit analyses.

    The biggest risk seems to be the effective bank nationalisation which I understand exposes the taxpayer to unlimited risk. Consequently immediate and tight government control of all bank activity would appear required.

  15. “It will take a long time to restore the budget balance after the kind of stimulus that is needed here.”
    What an understatement. The world has gone mad with the clowns printing more money that will be the ruin of us all like Zimbabweans. No sooner had they flung the truckloads of the stuff from the balconies, stock markets soared in a day and currencies that had no reason to rebounded did likewise. In Oz we had just suffered a flight from our dollar, when an unlimited guarantee of bank deposits, coupled with spending of fictitious surpluses caused a complete about face. These surpluses are illusory because they are funny money entries in computers, rather than warehouses full of plasmas, tanks full of oil or heaps of iron ore. The Govt doesn’t own one iota of these things that represent real savings for investment or simply more consumption. All they can do is create more credit at throwaway prices below the rate of their past induced inflation, all the while smashing the real productive sector. These court jesters can only play to the gallery for so long before the reality of what they’re doing sets in. Creating false dawns with smoke and mirrors will bring on an even bigger crisis of confidence when this smoke finally clears. We are being governed by complete idiots, but then we get the Govts we deserve after believing in something for nothing for so long. Economic armageddon it must be then to bring us to our senses now. So a new epoch begins- ‘Were you born pre-2007 or post-2007?’

  16. “Economic armageddon it must be then to bring us to our senses now. ”

    I’m struck by how many people, on both the left and the right, WANT a massive economic collapse.

    Hopefully they will all be disappointed.

  17. Damocles says, “I’m struck by how many people, on both the left and the right, WANT a massive economic collapse.”

    It’s hanging over our heads like… the Sword of Damocles.

    Voicing an opinion that one fears something will happen or something is likely to happen or something of necessity must happen is not the same as wanting it to happen. Yet granting all that, there are those of us who want to see a world which uses its resources at a sustainable rate rather than at the present climate destroying and environment destroying rate.

    An unregulated market does not allocate resources efficiently. An unregulated market does not allocate resources sustainably. A regulated market would do both of these tasks better. The curent US housing boom and bust cycle resulting from an under-regulated market has created a vast stock of housing which is now vacant, deteriorating and even being flattened by the bulldozers. This is dreadfully wasteful and destructive in an era of dwindling resources.

  18. A regulated market would do both of these tasks better.

    That sounds like blind faith in regulation as if regulation or any kind will do and as if no regulation ever had negative consequences. Surely you could stick with advocating some specific regulation instead of just simplisitically advocating regulation. Regulation isn’t some magic potion that always delivers the good stuff. Sometimes it’s a toxic poison.

    And there is no way anybody could seriously consider the current market place unregulated. If the current regulations are bad regulations then surely that should offer a cautionary tail against reflexively praying for regulation of any variety.

    What we need is not more regulation but different regulation. And different regulation may in fact entail less regulation in some areas. An analogy might be the structures that hold up a bridge. Structures add strength but they also add weight. More structures doesn’t automatically mean a better bridge. The aim should be to build a bridge strong enough for the load with the minimal number of structures.

    Another analogy might be wings on an airplane. Wings provide lift but they also provide drag. More wings does not necessarily make for a better airplane.

  19. This is a question for those who know money markets: can the world survive without Wall Street? (I am serious) Noting that their market dropped back again early this morning, do we need a plan B in which financial mechanisms are changed so that they are not dependant on any one financial centre? People have been talking about the US dollar no longer being the standard/reserve currency for some time. Is that time now?

    I don’t pretend to know the feasibility or consequences of doing this but, with the rest of teh world seemign to stabilise but Wall Street still nervous (presumably about what it knows about its own accounts that they haven’t revealed) is the solution to “cut Wall Street loose” and establish channels for supplying credit that are independant of it? If the Mid East, China and Japan supply the majority of the capital, why don’t borrowers just deal directly with them? Apology if there is some obvious reason why this is crazy.

    I should add that this question is in part based on my experience of Finland’s economy after the collapse of the former Soviet Union in the early 90s. The vast majority of their trade had been with USSR and they suffered huge losses when it collapsed (many debts unpaid). They simply wrote the money off and started again focused on trade with teh west. It worked.

  20. Spot on Socrates. There’s no shortage of capital globally, just a shortage at the current nanny staters’ manipulated prices and sops to those who got themselves so geared and hocked up on credit.

    Sweet Jesus! For one moment I almost fell for the siren song of these ‘concerned’ Louis Leeches who oversaw the printing of money to unleash the Gordon Geckos on us all and are now running about with more of their nosewiping largesse to saddle our grandkids with. It’s time to liquidate the inflated asset prices of those who can’t continue to pay for them and put them in the hands of those who can, at whatever fire sale prices the market throws up. If that’s Asian savers, or ME accruers of our IOUs then so be it. The sooner the gross misalignment of stock and RE prices are brought back into some reasonable relativity with real income earning capital the better off we’ll all be. As for attempting to protect the retirement asset prices of a generation that failed to reproduce the human capital to sustain them in old age, that’s impossible now. They’ll need to get used to working and putting in until they drop, or consuming what deflated real capital they have left. That goes for those in the public sector too now that it’s obvious young taxpayers can’t continue to prop them up- article dump deleted
    Final warning here. Anything further from you (a) reproducing a news article,(b) linking to sources we really should read to get the real picture or (c) referring in any way to the South Australian government will be met with deletion and a time-out JQ

  21. “The sooner the gross misalignment of stock and RE prices are brought back into some reasonable relativity with real income earning capital the better off we’ll all be.”

    So Observa, since you’re invoking the examples of zimbabwe and the Weimar Republic what inflation rate are you predicting for Australia for the next year?


    If it comes in under 10% (personally I’d expect under 5) will you admit you’ve been talking nonsense?

    Or will you just shift the date of doomsday out by another year?

  22. Agreed from America! This “economic crisis” of course, carries kegs of pain, but if it was left to fruition[which the world has decided otherwise] it would be the best thing for the average person. The bull crap numbers on inflation aren’t even close, and people are being squeezed the world over. The collaspse itself was caused by inflation[asset overvaluation] and the worlds silly infatuation with the worthless American dollar. Prices would be brought into line and the fat on top would be trimmed and neoliberlism would face the sharpened blade of its own knife. I beg you to leave the dollar behind and instate a world monetary system linked to the hop count within a barrel of Molson! I gaurantee it to be more reliable.

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