Over the fold, my column in yesterday’s Fin. Not the final version, as I made some last minute changes in response to Lindsay Tanner’s defence of the Razor Gang yesterday.
If there is one thing that has become evident from the grim macroeconomic news of the past couple of months, it is that the global economic crisis will last well beyond 2009. Global trade is collapsing, and the World Bank has recently forecasting negative global growth for the first time since World War II.
On these projections, it is optimistic even to hope that the decline in economic activity will level out in the course of this year. Moreover, weakness in private demand, particularly investment demand, is likely to persist for years into the future.
To suppose that the fiscal and monetary stimulus measures announced so far represent an adequate and complete response to the problem is unrealistic wishful thinking. Yet it is precisely such wishful thinking that seems to be shaping the planning of the Budget to be released in May.
Both in public statements and in private discussions with various interest groups, the government is indicating that expenditure will be tightly constrained as a consequence of declining revenues and the need to finance the stimulus packages announced so far. Lindsay Tanner has proposed a cap of 2 per cent on new spending, and the government is backing away from promises made during the election campaign.
In effect, this amounts to partially withdrawing, in May, the stimulus introduced only three months earlier. That would make sense if the problem were a short-term crisis of confidence, as some commentators suppose during the near-meltdown of late 2008. It makes no sense if, as seems certain, further rounds of stimulus are going to be needed before the crisis is over.
Of course, the crisis will not last forever, and the budget must be balanced in the long run. Given the cost of additional stimulus measures and the decline in revenue projections, the government cannot achieve this goal and deliver on all its electoral commitments.
The critical question is, what changes to the government’s plans are most consistent with the need to provide substantial stimulus for the next year or two, and replace weak private sector demand, while allowing a return to surplus in the medium term and the achievement of long-term budget balance.
The obvious candidate for change is the tax cuts, originally promised by the Howard government, but matched, with marginal changes, by Labor. The idea of promising large tax cuts on the basis of projected revenue growth was criticised strongly at the time, and many economists urged the Rudd government to abandon these commitments in its first budget.
At the time, the government rightly judged that the importance of keeping faith with the voters was paramount, and that nothing had changed since the election to justify repudiating a promise, even an ill-judged one (Promises a core responsibility, Australian Financial Review, 8 May 2008).
But now everything has changed. The surpluses out of which the tax cuts were to be paid have vanished. A substantial part of the tax cut was compensation for anticipated bracket creep, on the basis of anticipated inflation that is no longer likely.
In real terms, the tax cuts are larger, and more unaffordable, than when they were promised, even as the real capacity of the government to finance any tax cut has diminished. To keep this promise, the government will have to break many others, abandoning core commitments like the ‘Education Revolution’.
It is hard to imagine any policy instrument less appropriate to our current circumstances than a permanent tax cut, heavily tilted towards upper-income earners. The proposed tax cuts for July 2009 offer a paltry $3 a week to anyone with an income under $80 000, and nothing at all for those under $34 000. The biggest proportional benefit accrues at individual incomes of $180 000 a year. Such regressive tax cuts will do little good in the short run, either to boost consumption, or to repair the balance sheets of middle and lower-income households.
And in the long run, the implications of the government’s policy are even worse. Tight limits on spending will make it impossible to respond to the long downturn that seems increasingly likely. Delivering the tax cuts will tie the government’s hands for years to come.
When a car swerves sharply to avoid an obstacle, anything unsecured inside it continues travelling in its original direction, with unfortunate consequences. The same thing is happening in the Budget process. It is time for the government to recognise that this is more than a bump in the road, and adjust its priorities accordingly.First Sunday full movie