Changing course

When a car swerves sharply to avoid an obstacle, anything unsecured inside it continues travelling in its original direction, often with unfortunate consequences. We can see something similar happening with the Rudd government’s fiscal policy. The $42 billion stimulus package is as sharp a swerve as you can imagine, justified by the correct expectation that private investment and consumption demand, along with export demand, is about to collapse, leaving government to fill the gap.

Yet the noises coming out of the Budget process suggest that no one has even noticed this. Lindsay Tanner is still talking about spending cuts, as if the emergency measures of the last week can be put into reverse in only a few months time.

And, despite the disappearance of the forward surpluses that were to pay for them, and of any possible economic rationale for aiding high income earners, the government is still promising to proceed with the tax cuts promised in the utterly different world of 2007. Unlike many economists, I supported the government’s delivery of the first-stage tax cuts, on the basis that, while they were bad policy, nothing had changed since the election to justify repudiating a promise. But now, everything has changed. Like Ross Gittins, I hope the government will summon up the courage to say that tax cuts are off the agenda for the foreseeable future.

Update

I spell out the rationale for this a bit more over the fold

Given that tax cuts are generally seen as expansionary, why do I say they should be scrapped? A Keynesian tax cut should be temporary and targeted at those below median incomes, who are mostly likely to spend it, and, if they save it, most likely to need the money to balance their household budgets. The “temporary” point is most crucial. Once this mess is over, higher taxes are going to be needed for a long time, both to service and repay debt and to finance the permanently larger role for government inevitable in the light of the collapse of the financial sector.

By contrast, the tax cuts proposed by the Howard government, and copied by Rudd Labor during the 2007 campaign were permanent and targeted towards those in the top half of the income distribution (under the conventions of Australian politics, this group normally referred to as “middle-income earners”) but polite conventions do you no good when the fiscal ship is sinking.Crazy Girls Undercover film

32 thoughts on “Changing course

  1. John, I thought of adding the following here for I believe Pacific Brands is taking everyone for a ride. According to their 2008 half yearly report, the impairment (losses) of $206,443,000 included goodwill, brand names and other assets but essentially it was the result of declining economic outlook in several countries where the Company now operates. Maybe the company should come clean and explain what is really happening within their overseas operations.

  2. John, could you elaborate a bit on “the permanently larger role for government inevitable in the light of the collapse of the financial sector”?

    Tighter financial regulation (even if needed here, so far we have come off pretty lightly) would not mean higher taxes. One might favour permanently higher enviromental or social spending, but it is not clear how the financial mess makes this more urgent.

  3. Declan, I have been wondering the same thing myself. I can’t see any reason why the GFC is a justification for higher taxes or public expenditure.

    If you believe that the GFC was caused by reckless private financial institutions lending excessively without proper risk assessment, then this might well be an argument for some increased regulation of lending (such as tighter restrictions on how much money can be lent to various people or businesses). But it doesn’t follow that this must also necessitate higher taxes and public expenditure.

    Nor does it seem fair that all private businesses and workers deserve to be slugged with higher taxes just because a few Masters of the Universe got carried away with themselves.

    The whole argument seems to boil down to a basic ideological conflict, i.e. your side has taken a hit, so our side gets to impose more of what we want to do.

  4. Actually, the GFC is a perfect example of what happens when greed and stupidity coalesce.

    You have stupidity in the form of central banks increasing the money supply too quickly and creating asset bubbles, plus governments exacerbating the problem with various regulatory and taxation measures that distort the economy.

    Then you have the financial industry and investors chasing these unrealistic returns for all they are worth.

    Indeed, greed without stupidity doesn’t do too much damage. And stupidity without greed is mitigated somewhat.

    But greed and stupidity combined produce disastrous outcomes. If no-one else has named this phenomenon, maybe I can call it Monkey’s law.

  5. Monkey’s Uncle you’re violating the primary rule of discussing the GFC to wit, you’re neglecting to claim that it is either:

    a. exclusively the result of oppressive Big Government; or

    b. exclusively the result of the capitalist oppressors once again swindling the oppressed masses.

  6. ‘Let’s temporarily abolish income tax.’
    As I recall the amount of Obama’s fiscal package would allow the US to do that for a year and getting your gross wage in your hand you’d imagine would be about as stimulatory as it gets.

    However the Rudd Govt does have a golden opportunity here to get out of breaking that ‘core promise'(really a Howard card superbly played in the campaign) and solve their dilemma with those weak CPRS targets and handouts. It has tax reform on the agenda and can easily substitute a carbon tax for income tax to its hearts content. What could Turnbull say if wedged with that policy change but be left arguing over the fine details? Straight carbon taxing always belts the wealthy hardest as distinct from allowing them to buy their way out with spurious offsets, not to mention engage in speculative returns and economic rent from derivatives trading. The alternative is starve or lie beast, while looking weak on CO2 with that emasculated CPRS. Howard would be chuckling over their predicament now.

  7. Actually if you cast your mind back to the election campaign Rudd could have taken the political risk over the Costello tax cut package and ducked the ‘meetoo’ stance for a general statement on rejigging tax in office more for ‘working families’. He didn’t and is paying that price now with a core promise of Costellos. Once he took the safe road he was probably bound to meetoo Costello because it had the benefit of incumbency and detailed Treasury costings, whereas anything else at short notice wouldn’t, with the concomitant risk of black holes, etc That incumbency probably gave him an offer he couldn’t refuse and Howard knowing he would probably lose the election would be comfortable with that legacy. As I pointed out at the time the Libs could leave office with their ‘low tax’ credentials intact, despite the reality of Govt as a proportion of GDP.

    Of course if by some miracle Howard survived the Libs would have been in the same bind now and certainly Costello foresaw stormy seas ahead at the time and plugged the steady hand at the tiller theme. Rudd had fair warning about his safe ‘meetoo’ road choice right then and there. Interesting to speculate where a chastened but surviving Howard/Costello Govt would be now. No sorry, wait and see on Kyoto and no gabfest cost but I’m sure he’d have bailed ABC Learning and probably thrown the greenies some pink batts and the car industry a green stimulus/bailout bone. He’d have kept his powder dry on last year’s handouts and would have rammed through the second tranche of tax cuts buying off NickX similarly, but he wouldn’t have that silly ETS commitment hanging over his head like the sword of Damocles.

    As an aside here the Brotherhood of St Laurence have raised the thorny problem of pensions and the future threat from demographics. Rudd needs to address the problem of house rich, income poor pensioners now and into the future. I’ve had my ear to the ground on that and there’s only one logical solution. The pension assets test must include the value of the home after an exemption for an amount up to the median house price. That’s fair to all particularly as you have to reward pensioners for saving and paying off a house up to a point. After that we need to reduce pension entitlement for RE wealth just like any other, albeit you don’t want to force pensioners out of their traditional home just because it’s in a very desirable area now. The solution is they accrue a lien on the house above the exempt median price a bit like a HECS debt in order not to affect their pension income now. Demographics demands this reform urgently now.

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