Treasury explains why we shouldn't worry about the economy

There’s a lesson for Scott Morrison in new Treasury secretary Dr Steven Kennedy’s first public speech this week: put the right person at the top of Treasury and they’ll defend the government’s position far more eloquently and persuasively than any politician could. The econocrat’s greater credibility demands they be taken seriously.

I fear that time will show it's been a costly mistake by the government not to respond to Reserve Bank governor Dr Philip Lowe’s unceasing requests for budgetary stimulus to supplement the diminishing effectiveness of interest rate cuts. Costly in terms of lost jobs – perhaps even including the Prime Minister’s.

But that Kennedy’s opening statement at Treasury’s appearance before Senate Estimates is a robust defence of official policy should surprise no one (except politicians, who are prone to paranoia). In my experience, senior Treasury officers never gainsay the government of the day, in public or private. If it’s an independent view you’re after, try the Reserve.

However, since this is the most ably argued exposition of the government’s case for sitting tight, it deserves to be reported in detail.

Kennedy is clearly worried about the threat to us from events in the rest of the world, but is
"cautiously optimistic" that the domestic economy will pick up. According to the government’s long-established "frameworks" for the respective roles of the two policy arms used to manage the macro economy – monetary policy (interest rates) and fiscal policy (the budget) – the heavy lifting is done by monetary policy, with fiscal policy being used only during a crisis. As yet, there’s no crisis.

Over the past year, Kennedy says, global growth has slowed. As a result, the International Monetary Fund and the Organisation for Economic Co-operation and Development now expect world growth this calendar year to be the slowest since the global financial crisis in 2008. Even so, they expect growth next year to improve to about 3 to 3.4 per cent – "which is still reasonable".

Chief among the factors involved are the ongoing and still evolving "trade tensions" between the United States and China. "There is no doubt that trade tensions are having real effects on the global economy, which you see in trade data from the US and China," he says.

Combined with other problems – Brexit, Hong Kong, and concerns about the financial stability of some countries – trade tensions are leading to an increased level of uncertainty around the outlook for the world economy.

Many central banks have responded to slowing global growth by supporting their economies. And South Korea and Thailand have also provided more supportive fiscal policy.

Turning to the domestic economy, it slowed in the second half of last year, then grew more strongly in the first half of this year. This amounted to growth of just 1.4 per cent over the year to June.

Household consumption, the largest part of the economy, grew by 1.4 per cent, held down mainly by weak growth in wages. Linked to this is a fall in home building over the past three quarters, which is likely to continue in the present financial year.

Moving to business investment spending, mining investment fell by almost 12 per cent over the year to June, and non-mining investment was weaker than expected.

But, Kennedy argues, these problems are temporary and "there are reasons to be optimistic about the outlook". Recent figures have shown early signs of recovery in the market for established housing. Overall, capital city house prices have risen for the past three months. Auction clearance rates have picked up and more homes are changing hands.

Consumer spending will be supported by the government’s tax cuts and the Reserve’s three cuts in interest rates.

The substantial investment in mining capacity of past years is boosting exports, and mining investment spending is expected to grow this year rather than contract, as it had been since 2012.

Despite modest growth in the economy, employment has continued to be strong, increasing by more than 300,000 over the past year. The rate of unemployment has been "broadly flat" rather than falling because near-record rates of new people are joining the labour force and getting jobs.

The rate of improvement in the productivity of labour – output per hour worked – has averaged 1.5 per cent a year over the past 30 years, but slowed to just 0.7 per cent a year over the past five. This isn’t as bad as it looks because it’s exactly what arithmetic would lead you to expect when employment is growing faster than output. And even 0.7 per cent is higher than the G7 economies can manage.

Now to the question of whether the government should be applying fiscal stimulus to guard against a recession.

Kennedy says that, in an open economy such as ours, having a medium-term "framework" (set of rules) for the way fiscal policy should be conducted, in concert with a medium-term framework for the way monetary policy should be conducted, "has long been held to be the most effective way to manage the economy through cycles".

Under this view, fiscal policy’s medium-term objective is to deliver sustainable patterns of taxation and government spending [and thus a sustainable level of public debt].  A further objective is usually to minimise the need for taxation, as is the case in Australia.

This approach reflects an assessment that apparent short-term economic weakness or, alternatively, unsustainably strong growth, is best responded to by monetary policy, not fiscal policy.

Within this framework, however, the budget’s in-built "automatic stabilisers" will assist monetary policy in stabilising the economy. For instance, revenue will weaken, and payments will strengthen, when an economy experiences weakness.

The other exception to the rule that fiscal policy should be focused exclusively on achieving sustainable public debt is that there’s a case for "temporary [note that word] fiscal actions" in periods of crisis.

But "the circumstances or crisis that would warrant temporary fiscal responses are uncommon".

So, sorry, Phil. Application denied.

Read more >>

Morrison’s hang-ups make him a bad economic manager

Scott Morrison’s problem is that he gets politics – and is good at it – but doesn’t get economics.

The Prime Minister doesn’t get that if he keeps playing politics while doing nothing to stop the economy sliding into recession, nothing will save him from the voters’ wrath.

Neither he nor Josh Frydenberg seem to get that if we endure another year of very weak growth before they pop up next September boasting about their fabulous budget surplus, no one will be cheering.

How could a second financial year of weak growth possibly leave the budget with a big surplus? Because of the miracle of continuing bracket creep and iron ore prices kept high by BHP’s dam disaster in Brazil.

If there was any doubt about the likelihood of continuing weakness in our economy – independent of any adverse shock from abroad – it was swept away last week. The International Monetary Fund forecast real growth in Australia's gross domestic product of just 1.7 per cent this calendar year, improving only to 2.3 per cent next year.

So the IMF isn’t buying even Reserve Bank governor Philip Lowe’s “gentle turning point”, much less the efforts of Treasury’s seemingly unsackable Italian forecaster, Dr Rosie Scenario.

Frydenberg’s response has been that giving top priority to achieving a budget surplus isn’t just “a vanity exercise” because “a strong budget position helps build the resilience of the economy for external shocks, whenever that may occur, and your ability to respond to those stocks with a fiscal response”.

Translation: we can’t afford to spend money staving off recession because we’ll need to spend that money once we are in recession. The absurdity of this argument that a stitch in time doesn’t save nine has been hidden by his unstated assumption that, since the domestic economy's going fine, it’s only some shock from abroad that could lay us low.

Remember all the hand-wringing about quarter after quarter of weak growth in real wages, made even weaker – as Lowe has reminded us – by exceptionally strong growth in income tax collections? It’s imaginary, apparently.

Weak consumer spending, weak growth in business investment spending, contracting home-building? More imagining.

Oh yes, employment’s still growing surprisingly strongly. “See, I told you everything’s fine.” These guys are in denial.

Frydenberg’s argument about the need to “reload the fiscal canon” ready for the next downturn makes perfect sense - provided you’re paying back public debt at a time when the economy’s growing strongly and, if anything, could use a bit of slowing to ensure inflation doesn’t get away.

That's not us, unfortunately.

The IMF says “monetary policy [changing interest rates] cannot be the only game in town. It should be coupled with fiscal [budgetary] support where fiscal space is available, and policy is not already too expansionary”.

Far from being too expansionary, our fiscal policy is contractionary (which is why the budget balance is improving even as the economy slows).

And throughout the time that both sides of politics have been so worried about “debt and deficit”, the IMF has kept telling us not to worry because we have loads of “fiscal space” – that is, our level of public debt is way below the point where we should become concerned.

My bet is Morrison and Frydenberg will eventually panic and take stimulatory measures (probably a lot of them), but they’ll come too late in the piece to stop confidence unravelling, with punters tightening their belts as businesses lay off staff.

But not yet. Frydenberg has let it be known the government will try to boost business investment by introducing a special investment allowance – but not until the budget next May.

Even so, Finance Minister Mathias Cormann has let it be known that they’re thinking about turning the December midyear budget update into a mini budget if it soon becomes apparent the present tax and interest-rate cuts haven’t made much difference.

But even when that bullet is bitten, Morrison’s effectiveness as an economic manager will still be inhibited by his various political hang-ups. For instance, neither he nor his Treasurer can bring themselves even to utter the offensive S-word – stimulus.

And his determination never to be seen helping the poor (whom those in the party’s base know to be utterly undeserving) stops him taking two stimulatory measures that are simple, quick-acting and highly effective, while yielding lasting benefits.

The first is simply increasing the Newstart allowance.

The other is a proposal worked up by Dr Peter Davidson for the Australian Council of Social Service for the feds to invest $7 billion over three years building 20,000 social housing dwellings. This would not only boost growth and jobs in the becalmed housing industry, but also reduce homelessness.

Sorry, makes too much sense.

Read more >>

Politicians too poor at their jobs to fix poverty

You could be forgiven for not knowing this is anti-poverty week. The poor, as we know, are always with us – which is great because it means we can focus on our own problems and worry about the poor’s problems later.

We can fight to protect our tax breaks, then get around to wondering about how easy we’d find it to be living on $280 a week from the Pollyanna-named Newstart allowance.

But it’s not just our natural tendency to let our own problems loom larger than other people’s. It’s also that, as property prices make our cities ever more stratified, we so rarely meet people from the poorer parts of town.

We find it hard to imagine how hard they find it to make ends meet, and to lift themselves out of the hole they’ve fallen into. Why can’t they work as hard as I do? (Short answer: because they can’t find anyone willing to give them a job.)

Why can’t they budget as carefully as I would if I were in their position? (Short answer: you have no idea of how carefully they have to watch their pennies.)

The question we should be asking, but rarely do, is: why hasn’t their luck been as good as mine?

Why didn’t they choose their parents more wisely? Why didn’t they go to a better school? Why can’t they afford health and car insurance? Why don’t they have a few thou in the bank in case of emergency? Why don’t they have well-placed relatives and friends to help them find a job or talk their way out of a problem with the authorities?

One of the many things the Salvos (my co-religionists) do to help the disadvantaged is run a financial counselling service called Moneycare. I’ve been reading some of their recent reports, most of them prepared by the Salvos’ research analyst, Lerisca Lensun.

It probably won’t surprise you that the number of people seeking help has increased by more than 40 per cent over the past five years. Most are there because of an unexpected change in their financial circumstances – they’ve lost their job or lost income, they or a family member have acquired a serious illness, or they’re victims of domestic violence.

The main issues they present with are managing their debt, or managing their budget. More than a third of people in the sample had financial difficulties arising from health problems.

More than 60 per cent of those needing financial counselling are women. The median income was $535 a week, less than 40 per cent of an average Australian’s income and well below the poverty line.

A quarter are on Newstart and another fifth on the disability support pension.

Almost half rent privately and, of these, 45 per cent suffer housing stress (paying more than 30 per cent of their disposable income in rent), plus a further 26 per cent in severe housing stress.

The proportion of those over 55 who are in private rental has risen over a decade from 27 per cent to 42 per cent. Of these, almost 80 per cent experience housing stress.

Of those with debt, half have credit card debt, 30 per cent have personal loans and a quarter have electricity debt. Many have more than one type, of course.

Compared with average Australian households, clients spent at least 50 per cent less on essential items such as food and health. Try this story from a 41-year-old mother of three: “Go without the main meal and just provide for the children. Before payment arrangements were organised, I would put off paying electricity and gas bills to pay for other things due.”

Or this sick 26-year-old woman, living alone: “When I don’t have money I don’t eat and only get the medication I could not live without. Bills and debts get fines. The medical conditions get worse so I end up needing more medication and get admitted to hospital to fix that.”

The counsellors at Moneycare – who spend much time interceding with creditors on behalf of clients – say they see no sign on the ground of improved behaviour by lenders since the report of the royal commission on banking misconduct.

They worry a lot about the way unscrupulous payday lenders take advantage of people with pressing debts and no money, greatly deepening the hole they’re in. Legislation to crack down on such lenders was introduced to Parliament in March last year, but has yet to be passed.

It never ceases to surprise me that a prime minister so ready to proclaim his Christian faith is so hard of heart when it comes to people on benefits (age pensioners excepted). Presumably, he’s not prepared to “give them a go” because he’s not convinced that they “have a go”.

As the Australian Council of Social Service has said, increasing Newstart would be “the single most effective step to reduce poverty” – not to mention giving a much-needed boost to the nation’s retailers.

But Scott Morrison, so generous in his promises of big tax cuts to high-income earners like me, has steadfastly refused to oblige. Rather, he’s working on an unending list of torments for people on welfare.

It’s as if he’s seeking applause from all those who think anyone on welfare must be a lazy loafer.

If that’s how you imitate Christ, things have changed a lot since I grew up in the Salvos.

Read more >>

Why surpluses aren't necessarily good, or deficits bad

According to the Essential opinion poll, only 6 per cent of people regard the size of the national surplus as the most important indicator of the state of the economy. I think that’s good news, but I’m not certain because I’m not sure what “the national surplus” is – or what the respondents to the poll took it to mean.

They probably thought it referred to the balance on the federal government’s budget. But the federal budget is not yet back to surplus and, in any case, it can’t be the national surplus because it takes no account of the budgets of the state governments that, with the feds, make up the nation.

Assuming respondents took it to be the federal budget balance, its low score is good news about the public’s economic literacy, but bad news for Scott Morrison and Josh Frydenberg, who are hoping to make a huge political killing when, in September next year, they expect to announce the budget finally is back in surplus.

The pollies are assuming that voters know nothing more about the economy than that anything called a surplus must be a good thing, whereas anything called a deficit must be very bad.

Actually, no economist thinks all surpluses are good and all deficits bad. Sometimes surpluses are good and sometimes they’re bad. Vice-versa with deficits. It depends on the economy’s circumstances at the time.

But the confusion doesn’t end there. There are lots of measures in the economy that can be in deficit or surplus, not just governments’ budgets. When I wrote a column some weeks back foreshadowing that the current account on the nation’s balance of payments would probably swing into surplus for the first time in 44 years, some people assumed I must be referring to the federal budget.

Wrong. The federal budget records the money flowing in and out of the federal government’s coffers – it’s bank account. The “balance of payments” summarises all the money flowing into and out of Australia from overseas – covering exports, imports and payments of interest and dividends in and out (making up the “current account”), and all the corresponding outflows and inflows of the financial payments required (making up the “capital and financial account”).

The trick is that, thanks to double-entry bookkeeping, the balances on the two accounts making up the balance of payments must be equal and opposite. So the longstanding deficit on the current account was always exactly offset by a surplus on the capital account.

And that means the (probably temporary) current account surplus was matched by the capital account swinging from surplus to deficit. Oh no.

Although Australia has been a net importer of (financial) capital almost continuously since the arrival of the First Fleet, for the June quarter we became a net exporter, lending or investing more money in the rest of the world than the rest of the world lent or invested in us.

If you tell the story of this change in plus and minus signs from the current account perspective, it’s mainly that the resources boom has greatly increased our exports, while the slowing in the economy’s growth means our imports of goods and services are also weak.

But there’s also a story to be told about why the capital account has gone from surplus to deficit. As Reserve Bank deputy governor Dr Guy Debelle explained in a speech at the time, the composition of the inflows and outflows of financial capital have changed a lot since 2000.

Since Australia has always been a recipient of foreign investments in our businesses, by June this year, the value of the total stock of that equity investment amounted to a liability to the rest of the world of $1.4 trillion.

But the value of our equity investments in the rest of the world amounted to assets worth $1.5 trillion. So, when it comes to equity investment, the latest figures show we had net assets of $142 billion.

The fact is, the value of our shares in them overtook the value of their shares in us in 2013. That’s a remarkable turnaround from the previous two centuries of being a destination for foreign investment.

Why did it come about? Mainly because of our introduction of compulsory superannuation. Our super funds have invested mainly in local companies, but they’ve also invested a lot in the shares of foreign companies.

For the most part, however, our seemingly endless string of current account deficits has been financed by borrowing from the rest of the world. By June, our debt to foreigners totalled $2.4 trillion. Their debt to us totalled $1.3 trillion, leaving us with net foreign debt of a mere $1.1 trillion.

There was a time when Coalition politicians carried on about that debt – owed more by our banks and businesses, than our governments - rather than the (much smaller) debt of the federal government, only about 55 per cent of which is owed to foreigners.

Why does our huge net foreign debt rarely rate a mention these days? Because it’s always made economic sense for a young country with huge development potential to be an importer of financial capital – it’s part of what’s made us so prosperous.

Because all the debt we owe is denominated in Australian dollars or has been “hedged” back into Aussie dollars – meaning a sudden big fall in our dollar would be a problem for our creditors, not us.

But also because, though our net foreign debt keeps growing in dollar terms, our economy is also growing – and hence, our ability to pay the interest on the debt. That’s a sign that, overall, the money we’ve borrowed has been put to good use.

Adding our net foreign assets to our net foreign debt gives our net foreign liabilities. Measured against the size of the economy (nominal gross domestic product), our net foreign liabilities reached a peak of about 60 per cent in 2009, but have since fallen to about 50 per cent.

Read more >>

Want the jobless to find jobs? Then increase the dole

It’s so familiar a part of political economy you could call it Galbraith’s Law, after John Kenneth Galbraith, the literary Canadian-American economist who put it into words. As the late senator John Button paraphrased it: the rich need more money as an incentive and the poor need less money as an incentive.

Consider the first actions of the re-elected Scott Morrison and his government. First, pushing through its three-stage tax plan, which in time will cut the income tax of those on the minimum wage by 1.5¢ in every dollar, those full-time workers on the median wage by 2.4¢ in every dollar, and those on $200,000 a year by 5.8¢ in the dollar.

Second, steadfastly resisting the ever-mounting calls for a rise in the single dole of $278 a week (less than 38 per cent of the minimum wage), which hasn’t been increased beyond inflation since 1997, making it now about $180 a week less than the pension.

It’s true that, until very recently, Labor was just as opposed to raising the dole as the Coalition has long been. Why? Because both sides know that doing so would displease many of their supporters.

As everyone knows, the dole is paid to lazy youngsters, who much prefer surfing to looking for a job – which, if only they’d get off their arses, they’d soon find. (Never mind that the number of unemployed vastly exceeds the number of job vacancies.)

Even so, the number of those calling for an increase is mounting rapidly. Apart from the welfare groups, it has long included the Business Council, which has now been joined by various economists – including those working for two of the big four accounting firms, plus someone called Dr Philip Lowe – and backbenchers from both sides, including Barnaby Joyce, who says the dole isn’t high enough for country people to afford the travel to job interviews.

Even John Howard, the man who initiated the freeze in real terms, now says it’s time for it to end.

Morrison, however, is unmoved. He argues the dole is better than it's been painted. It’s increased twice a year in line with inflation, and 99 per cent of recipients get other payments.

True. But what the 99 per cent get is the “energy supplement”, which is worth 63¢ a day and doesn’t change the claim that the dole amounts to about $40 a day.

About 40 per cent of singles on the dole get rent assistance – of up to $9.80 a day – provided they’re paying rent of more than $21.40 a day which, rest assured, they are. Much more.

There are 722,000 people on unemployment benefits. Half of them are over 45 – strange to think how sure people are that employers discriminate against older job applicants, but don’t ever imagine them being on the dole.

Similarly, more than a quarter of recipients have an illness or disability, but are on the dole because they’ve been denied the disability support pension. These people, along with more than 100,000 single parents, face challenges and discrimination in finding paid work.

Another argument ministers use is that the dole was only ever intended to be a temporary payment while people find another job and, indeed, two-thirds of people going on to it move off within 12 months.

But get your head around this: accepting that’s true, it’s also true that, at any point in time, two-thirds of people on the optimistically named Newstart allowance have been on it for a year or more. These are the long-term unemployed who, presumably, include many of those with particular challenges.

I agree with Morrison that “the best form of welfare is a job”. It’s true, too, that in recent years many additional, full-time jobs have been created. But it’s equally true that many of those jobs have gone to immigrants and other new entrants to the labour force, meaning the rate of unemployment hasn’t fallen below 5 per cent. That’s acceptable?

The truth is that, even in the city, the meanness of the dole makes it hard for people to afford the transport and other costs needed to search for jobs. The notion that poor people will seek work only under the lash of poverty is heartless nonsense.

Other facts are that the economy has slowed sharply since the middle of last year, employment is growing more slowly and unemployment is now rising.

This is why Reserve Bank governor Lowe has twice cut the official interest rate and is begging the government use its budget to do more to stimulate the economy. It partly explains his support for an increase in the dole – an extra $75 a week is the popular proposal – which, as a stimulus measure, has the great virtue of being likely to be spent fully and quickly by its impoverished recipients.

So why the refusal? For the reasons we’ve discussed but also because, having given up tax revenue of $300 billion over 10 years, Treasurer Josh Frydenberg now insists he can’t afford a dole increase costing a whopping $39 billion over 10 years. Too much threat to his promised return to budget surplus.

Strange logic. Should the economy’s slowdown not be reversed, unemployment – and the budgetary cost of the dole – will go a lot higher, and hopes of budget surpluses will evaporate, replaced by angry people accusing the government of economic incompetence.

Read more >>

Poor Josh Frydenberg: on the wrong tram, heading for trouble

It’s not my policy to feel sorry for any politician – they’re all hugely ambitious volunteers – but I do feel sympathy for Treasurer Josh Frydenberg. He’s not the first treasurer to be strong on party dogma but light on economic understanding, but he’s among the first to be heading into stormy weather light on expert advice from a confident and competent Treasury.

There he was, thinking his first budget would be his last, primping up a pre-election budget that claimed to have fixed the economy and delivered on deficit and debt when that was all in the future and built on nothing more than years of wildly optimistic forecasts, combined with a massive tax bribe whose cost will keep multiplying for seven years.

Do you think that while cooking up the happy forecasts needed to justify his claims of Mission Accomplished and make his tax cuts seem affordable, Treasury warned him of the risks he was running, making himself and his government hostages to fortune?

I doubt it. They wouldn’t have been game to. The Coalition’s politicisation of Treasury, intended to kill its corporate sense of mission and replace it with people who’d proved their right-thinking and party loyalty as ministerial staffers, sent the message that the government wanted people who spoke only when spoken to and kept any contrary opinions to themselves.

In the process, however, most of the people with a deep understanding of macro-economic management have drifted away. People who understood the mysteries of the business cycle, with experience of recessions - and how excruciatingly painful they are for the government of the day.

These are people who know how much worse you make it for yourself – and for the economy voters depend on – by refusing to face the mess you’ve got yourself into, and who know how to help you change trams with as little loss of face as possible.

People game to tell you to stop digging. People who know that the longer you take to accept that the game has changed, the harder it will be to get the economy back on track – and, incidentally, to avoid getting the blame for completely stuffing it up.

People who’ll tell you to blame your about-face on changes coming from the rest of the world, but not to believe your own bulldust. People who’ll tell you to forget about party political doctrine – and the crowing of your opponents - and be completely pragmatic in doing whatever needs to be done to get you and the economy out of the poo.

Here’s what Frydenberg’s experts should be telling him, but probably aren’t – unless he speaks to Reserve Bank governor Dr Philip Lowe a lot more regularly than I imagine he does.

First, worrying about deficit and debt is something national governments can afford to do only when they’ve got an economy that’s growing strongly. The three successive quarters of pathetically weak growth we’ve experienced – complete with rising unemployment and underemployment - may prove to be just a blip, as the budget’s forecasts assume they will, but it’s much easier to believe they show the economy is fast running out of puff.

Recession is neither imminent nor inevitable in the next year or three, but with the economy in such a weakened state it is vulnerable to any adverse shock that happens along – whether of domestic or international in origin.

In such circumstances, it would be economically damaging and fiscally counterproductive (not to mention politically disastrous) to press on with fiscal consolidation rather give top priority to boosting economic activity and getting the economy back into strong-growth mode.

The problem is, the economy seems to be running out of puff because it’s caught in a vicious circle: private consumption and business investment can’t grow strongly because there’s no growth in real wages, but real wages will stay weak until stronger growth in consumption and investment gets them moving.

Policy has to break this cycle. But, as Lowe now warns in every speech he gives, monetary policy (lower interest rates) isn’t still powerful enough to break it unaided. Rates are too close to zero, households are too heavily indebted, and it’s already clear that the cost of borrowing can't be the reason business investment is a lot weaker than it should be.

That leaves the budget as the only other instrument available. The first stage of the tax cuts will help, but won’t be nearly enough. “Structural reform” is always a nice idea, but fixing a problem of deficient demand from the supply side would take far too long to be of practical help.

Over to you, Josh. If you’ve got the greatness in you, this could be your finest hour.

Read more >>

How to multiply the bang from your budget buck

Years ago, I came to a strong conclusion: the politician who could resist the temptation to use the budget to prop up the economy when it’s falling in a heap and making voters hugely dissatisfied has yet to be born.

So let me make a fearless prediction: whatever they’re saying now, sooner or later Treasurer Josh Frydenberg and his boss Scott Morrison will use “fiscal policy” (aka the budget) to help counter the sharp slowdown in the economy that, if we’re not careful or our luck doesn’t hold, could lead to something much worse.

How can I be so sure? Because I’ve seen it happen so many times before. As I wrote in this column last week, since the late 1970s it’s been the international conventional wisdom among governments and their advisers that “monetary policy” (interest rates) should be the chief instrument used to stabilise the economy as it moves through the ups and downs of the business cycle, with fiscal policy focused instead on achieving “fiscal sustainability” – making sure the public debt doesn’t get too high.

Take Malcolm Fraser, for instance. He spent almost all his time as prime minister trying to eliminate the big budget deficit he inherited from the Whitlam government.

Until, that is, his advisers noticed indications of what became the recession of the early 1980s. In his last budget, he cut taxes and boosted government spending.

The Hawke government was totally committed to leaving it all to monetary policy, and stuck to that even when Treasurer John Kerin brought down the 1991 budget during the depths of the recession we didn’t have to have in the early 1990s.

Except that, by this time, Paul Keating was on the backbench, telling everyone who’d listen that you’d have to be crazy not to be using the budget to stimulate the economy.

In February 1992, soon after he’d deposed Bob Hawke, Keating unveiled his own big One Nation stimulus package – which by then was far too late.

It was Dr Ken Henry’s realisation at the time that politicians will always do something, even if they should have done it much sooner that, after the global financial crisis in 2008, saw him urging Kevin Rudd to “go early, go hard, go households”.

Combined with a cut in interest rates far bigger than would be possible today, that fiscal stimulus was so effective in keeping us out of the Great Recession that, today, the punters have forgotten there was ever any threat and the Coalition has convinced itself it was never needed in the first place.

Now, as we also saw last week, with interest rates so close to zero, fiscal policy is back in fashion internationally – though I’m not sure the carrier pigeon has yet made it as far as Canberra. So we’ve got time for a quick refresher on how fiscal stimulus works while we wait for the penny to drop in the Bush Capital.

There is a “circular flow of income” around the economy, caused by the simple truth that one person’s spending is another person’s income. This means that $1 spent by the government (or anyone else, for that matter) can flow around the economy several times.

This is what economists call the “multiplier” effect. Just how big the multiplier is for any spending will depend on the “leakages” from the flow that happen when someone decides to save some of their income rather than spend it all, or when they spend some of their income on imported goods or services (including overseas holidays).

(There are also “injections” to the flow from investment – someone uses or borrows savings to spend on a new house or office or equipment – and from exports of goods or services to foreigners.)

This means that the degree of stimulus the economy receives will differ according to the choices the government makes about the form its stimulus will take.

In a briefing note prepared by Dr Peter Davidson for the Australian Council of Social Service, he quotes research on the size of multipliers calculated by the Congressional Budget Office for the various measures contained in President Obama’s stimulus package in 2009, after the financial crisis.

Where the government spent directly on the purchase of goods and services, $1 of spending increased US gross domestic product by between 50¢ and $2.50. Where the spending was money given to state governments for the construction of infrastructure, the multiplier ranged between 0.45 and 2.2.

For spending on social security payments, the multiplier ranged between 0.45 and 2.1. For one-off payments to retirees, it was between 0.2 and 1. For grants to first-home buyers, between 0.2 and 0.7.

Turning from government spending to tax cuts, the budget office found than tax cuts for low to middle income-earners yielded a multiplier of between 0.3 and 1.5. For tax cuts for high income-earners, it was between 0.05 and 0.6. For additional company tax deductions, it was 0.4.

These big differences aren’t hard to explain. Multipliers are highest for direct government purchases or construction because there’d be no initial leakage into saving and little into imports.

The multipliers for tax cuts are lower because of initial leakage into saving and imports – not so much for low and middle income-earners, but hugely so for high income-earners.

Davidson’s conclusion is that a fiscal stimulus package would give the biggest bang per buck if it focused on direct government spending (particularly on timely infrastructure projects) and transfer payments to social security recipients.

Unsurprisingly, he slips in a plug for a $75 a week increase in dole payments to single people and single parents which, because it went to the poorest households in the country, would be spent down to the last penny and on essentials such as food and rent, not imports. It would also go to the poorest regions in the country.

Sounds good to me – and also to Reserve Bank governor Dr Philip Lowe.

Read more >>

Kiwis go one up and bring happiness to the budget

Like the past, New Zealand is a foreign country. They do things differently there. While we’ve just had a budget promising what seems like the world’s biggest tax cut, the Kiwis have just had what may be the world’s first “wellbeing budget”. Bit of a contrast.

I’ve long believed that all government politicians everywhere, when they’re not simply delivering for their backers, are trying to make voters happy and thus get themselves re-elected. They just differ in how they go about it.

Like governments everywhere, our governments of both colours have seen delivering economic growth - and the jobs and higher material living standards it’s expected to bring - as the chief thing we want of them to make us happier.

To this end they’ve adopted as their chief indicator of success the rate of growth in GDP – gross domestic product – which measures the nation’s production of goods and services during a period.
They’ve largely assumed that the extra income produced by this growth is distributed fairly between us - though, in recent decades, the share going to those near the top has grown a lot faster than the shares of everyone else.

This, presumably, is Australian voters’ “revealed preference”, since we’ve just rejected the party promising to cut various tax breaks going mainly to high income-earners and use the proceeds to increase spending on hospitals, schools and childcare, in favour of the party offering tax cuts worth an immediate saving of $1080 a year to middle income-earners and delayed savings of up to $11,640 a year to those of us on $200,000 and above.

According to the Liberal winners, voters in outer suburbs and the regions turned away from Labor because it would have dashed their “aspirations” to one day be earning two or three times what they’re earning today and so be raking it in from family trusts, negatively geared investments and, above all, refunds of unused franking credits.

But if our aspirations to happiness revolve around more money in general and less tax in particular, our cousins across the dutch aspire to a radically different brand of happiness.

According to their Finance Minister Grant Robertson, in his budget speech, New Zealanders were asking “if we have declared success because we have a relatively high rate of GDP growth, why are the things that we value going backwards - like child wellbeing, a warm, dry home for all, mental health services or rivers and lakes we can swim in?

“The answer to that question was that the things New Zealanders valued were not being sufficiently valued by the government . . . So, today in this first wellbeing budget, we are measuring and focusing on what New Zealanders value – the health of our people and our environment, the strengths of our communities and the prosperity of our nation.

“Success is making New Zealand both a great place to make a living, and a great place to make a life.”

According to the nest of socialists who’ve overrun the NZ Treasury, “there is more to wellbeing than just a healthy economy”. So GDP has been moved from its central place, replaced by Treasury’s “living standards framework”, based on the four sources of capital: natural capital (land, soil, water, plants and animals, minerals and energy resources), human capital (the education, skills and health of the population), social capital (the behavioural norms and institutions that influence the way people live and work together) and human-made capital (factories, offices, equipment, houses and infrastructure).

The living standards framework covers 12 “domains”: income and consumption, and jobs and earnings (which two cover GDP), and “subjective wellbeing” (the $10 term for happiness), plus health, housing, knowledge and skills, the environment, civic engagement and governance, time use, safety and security, cultural identity and social connections.

The wellbeing budget then set out five government priorities: improving mental health, reducing child poverty, addressing inequalities faced by Maori and Pacific island people, thriving in a digital age, and transitioning to a low-emission, sustainable economy.

I’ve often thought this would be the right way for governments to go about increasing “aggregate happiness” – by focusing on reducing the main sources of un-happiness.

To make a start, the budget provides almost $1billion over five years to improve the wellbeing of children, including extra funding for low-income schools, more help for children affected by domestic and sexual violence, and indexing family benefits to wages rather than prices.

The budget’s expensive mental health package includes creation of a new frontline service and funds to help people with mild-to-moderate mental health problems rather than making them wait until their problems worsen. Helping people with addictions is also seen as a health issue.

A “sustainable land-use” package works on the environmental challenges facing agriculture, including excess nutrient flows into iconic lakes and rivers.

Despite all this, the budget sticks to the government’s budget responsibility rules, with surpluses forecast and reduction of public debt. According to Saint Jacinda of Ardern, the wellbeing budget “shows you can be both economically responsible and kind”.

So, those uppity Kiwis think they can walk and chew gum at the same time. Fortunately, we Aussies know not to try.

Read more >>

Economic reform is stalled until politicians get back our trust

For those who care more about good policy than party politics, there are unpleasant conclusions to be drawn from the federal election. The obvious one is that it was a case of policy overreach leading to failure.

The less obvious one is that decades of misbehaviour by both sides have alienated so many people from the political process and turned election campaigns into such a cesspit of misrepresentation and dishonesty that, henceforth, neither side will be game to propose or implement controversial reforms.

The election was lost by the party proposing to remove a long list of sectional tax breaks and use the proceeds to increase spending on hospitals, schools and childcare, and won by the party that couldn’t agree on any major policies bar a humongous tax cut.

The risks to good economic policy are obvious. Labor concludes only a mug would try to get themselves elected on the back of good policy; the Coalition concludes you don’t need to be promising to do anything much to get re-elected.

Labor’s conclusion could be used to reinforce the political class’s widely held view that controversial reforms should only be pursued once in government, never from opposition.

Trouble is, the Coalition’s conclusion could be used to argue that, if you can get re-elected without any plans to fix things, why take the risk of proposing anything that could be unpopular?

But I think the threat to good policy runs even deeper. It comes from the electorate’s ever-growing disillusionment and alienation from politics and politicians, and from the two main parties in particular.

The vote for a changing array of third parties continued to rise, while the primary vote for both the majors was down – though more so for Labor than the Coalition. Until now, the rise of One Nation and other populist parties of the right has been a much bigger worry for the Coalition than the Greens have been for Labor.

This time, however, many former Labor voters in outer suburban and regional electorates used One Nation and Clive Palmer’s United Australia Party as a bridge to switch their vote to the Liberals.

In numerical terms, that’s why Labor lost. The point for good-policy advocates to note is that, when so many voters tune out of the political debate, but are still required to vote, they tend to make a last-minute choice based not on a well-informed assessment of how they would be affected by the rival parties’ policies, but on superficialities (“that nice Mr Rudd” or “Shorten looks shifty to me”), scare campaigns and negative advertising.

In other words, in a world where switched-off swinging voters aren’t even guided by informed self-interest, the scare campaign is king. To be blunt, the best liars win.

The Libs were convinced that former prime minister Malcolm Turnbull came so close to losing the 2016 election because of the success of Labor’s Mediscare campaign, conducted at the last minute using social media.

My theory is that, this time, the Libs resolved to turn the tables. This time they made much superior use of social media to run bigger scare campaigns about Labor’s “retirement tax” and “housing tax”. That was mere misrepresentation of Labor’s policies (most of which had strong support from economists and econocrats). The anonymous soul who dreamt up the “death tax” was an outright liar.

I think the biggest single reason so many outer-suburban and regional voters turned away from Labor was its opponents’ success (with much help from Palmer’s blanket advertising) in convincing those voters that Labor planned to increase their taxes.

My guess is that the next federal election will either see each side battling to out-scare the other – an orgy of lies - or, more likely, neither side being game to propose any reform of consequence, for fear of having it grossly misrepresented by the other side.

The more the bad behaviour of both sides – the broken promises, the hypocrisy, the spin, the abuse of statistics, the preference for bad-mouthing your opponents rather than explaining your policies – continues, the more both sides will turn from substance to empty populism.

And guess what? The more they do, the more voters will disengage and become more susceptible to lies and superficialities.

From the noises Anthony Albanese has been making, everything Labor did was wrong, and every triumphalist Liberal explanation of why Labor lost is right. The trouble with Labor selecting leaders from its Left faction is that they’re so anxious to prove they’re not left wing (which, these days, they aren't) they end up standing for nothing.

It would be nice if, having worked a miracle and established his authority over the Coalition’s warring tribes, Scott Morrison now turns his mind to fixing at least some of the many bits of the economy that need fixing. We can but hope.

Read more >>

As you were: getting back to budget surplus no longer urgent

Sometimes, changes in fashion are shocking. In economics, the fashion leaders are top American economists. Their latest fashion call is highly relevant to Australia’s circumstances, but will shock a lot of people: stop worrying so much about debt and deficit.

Among the various big-name economists advocating this change of view, the one who made the biggest splash was Professor Olivier Blanchard, of the Massachusetts Institute of Technology, in his presidential lecture for the American Economic Association early this year.

Blanchard was formerly chief economist at the International Monetary Fund, and had a big influence on the advanced economies’ response to the global financial crisis. He offered a simpler version of his lecture in a paper for the Peterson Institute for International Economics in Washington.

When governments spend more than they raise in taxes, they cover their deficit by borrowing via the sale of government bonds. If you run deficits for many years, you rack up much debt.

So the conventional wisdom – which we heard from both sides in the election campaign – has long been that, as soon as the economy has recovered from its downturn, governments should raise more in taxes than they spend, so as to run an annual budget surplus. They use the surplus to buy back some of the bonds the government has issued, and thus reduce its debt.

Why do most people – and many economists still - think this is the right thing to do? Because when you borrow money you have to pay interest. The more you borrow, the more interest. And the only way to stop having to pay interest is to repay the debt.

Blanchard calls this the “fiscal [or budgetary] cost”. In the end, interest payments and repayments of principal have to be covered by the higher taxes extracted from people, which may discourage them from working or distort their behaviour in other ways.

But Blanchard realised there may be no fiscal cost because interest rates are so low – especially for governments, whose debt is regarded as risk-free (or “safe” as he calls it). Governments are almost always able to repay their debts because, unlike the rest of us, they can get the money they need by increasing taxes. Or they could simply print more money.

Safe interest rates in the rich economies – including Australia – are so low that, after you allow for inflation, the “real” interest rate may be close to zero, or even negative. If they’re zero they’re costing the government nothing.

If they’re negative, the lender is actually paying the government to borrow from them (once you remember that, because of inflation, the lender will be repaid in dollars with less purchasing power that the dollars originally borrowed).

But that’s not all. A government’s revenue-raising capacity tends to grow in line with the size of the economy – nominal gross domestic product. And nominal GDP almost always grows faster than the nominal safe interest rate.

If so, the government can go on, year after year, paying the interest on its debt and continuing to run a budget deficit - provided it isn’t too big – without its debt growing relative to the size of the economy.

Now, you may object that interest rates are so low at present only because it’s taking so long for the world economy to recover from the global financial crisis and the Great Recession.

But if interest rates are higher in the future, that will be because there’s stronger demand to borrow relative to the supply of funds available, and this, in turn, should mean the economy is also growing at a faster rate.

In any case, Blanchard and others have shown that nominal GDP growth has been higher than the safe interest rate for decades.

So, unless budget deficits are very high, the value of the debt should decline over time as a percentage of GDP. This, in fact, is the way all countries got on top of the massive debts they incurred during World War II.

The second conventional reason for worrying about government debt is the cost to the economy, which Blanchard calls the “welfare cost”. When governments borrow to fund their deficit spending, they compete with private sector borrowers, driving up the interest rates firms have to pay and so “crowding out” some business borrowers.

This causes firms’ investment in renewing or expanding their businesses to be lower than otherwise which, in turn, leads to less economic growth and job creation than otherwise.

(That’s the standard argument, used since Milton Friedman’s day. It’s still relevant to an economy as huge as America but, in an economy as small as ours, it stopped applying after we floated the dollar and our financial markets became integrated with the global market. In Australia, if crowding out happens, it does so via the inflow of borrowed foreign capital causing our exchange rate to be higher than otherwise and thus making our export and import-competing industries less price competitive.)

But Blanchard argues that, in fact, the welfare cost of high government debt is probably small. If the average rate of return on business investment projects is higher than the rate of growth in nominal GDP, this implies there is a cost to the welfare of people in the economy.

On the other hand, if the safe interest rate is lower than the rate of growth in nominal GDP, this implies a welfare benefit from the government debt. Putting the two together implies that the welfare cost, if any, wouldn’t be great.

Blanchard is quick to warn, however, that these arguments don’t “add up to a licence to issue infinite amounts of [government] debt”. Debt and deficit make sense when government spending is countering the weakness in private sector spending. When this fiscal stimulus succeeds in restoring strong growth in private sector spending, governments should pull back to avoid excessive inflation pressure.

And, to be on the safe side, government borrowing should be used mainly to support investment in needed infrastructure, education and healthcare, so it’s adding to the economy’s productive capacity, not just to consumption.

Read more >>

Our new economic worry: Reserve Bank running out of bullets

Scott Morrison got the government re-elected on the back of a budget built on an illusion: that the economy was growing strongly and would go on doing so for a decade. The illusion allowed Morrison to boast about getting the budget back into surplus and keeping it there, despite promising the most expensive tax cuts we’ve seen.

The illusion began falling apart even while the election campaign progressed. The Reserve Bank board responded to the deterioration in the economic outlook at its meeting 11 days before the election.

It’s now clear to me that it decided to bolster the economy by lowering interest rates, but not to start cutting until its next meeting, which would be after the election – next Tuesday.

If that wasn’t bad enough for Morrison, with all his skiting about returning the budget to surplus he may have painted himself – and the economy – into a corner.

In a speech last week, Reserve Bank governor Dr Philip Lowe made it clear that cutting interest rates might not be enough to keep the economy growing. He asked for his economic lever, “monetary policy” (interest rates), to be assisted by the government’s economic lever, “fiscal policy” (the budget).

He specifically mentioned the need to increase government spending on infrastructure projects, but he could have added a “cash splash” similar to those Kevin Rudd used to fend off recession after the global financial crisis in 2008.

See the problem? Any major slowdown in the economy would reduce tax collections and increase government spending on unemployment benefits, either stopping the budget returning to surplus or soon putting it back into deficit.

That happens automatically, whether the government likes it or not. That’s before any explicit government decisions to increase infrastructure spending, or splash cash or cut taxes, also worsened the budget balance.

And consider this. The Reserve’s official interest rate is already at a record low of 1.5 per cent. Its practice is to cut the official rate in steps of 0.25 percentage points. That means it’s got only six shots left in its locker before it hits what pompous economists call the “zero lower bound”.

What happens if all the shots have been fired, but they’re not enough to keep the economy growing? The budget – increased government spending or tax cuts – is all that’s left.

The economics of this is simple, clear and conventional behaviour in a downturn. All that’s different is that rates are so close to zero. For Morrison, however, the politics would involve a huge climb-down and about-face.

My colleague Latika Bourke has reported Liberal Party federal director Andrew Hirst saying that, according to the party’s private polling, the Coalition experienced a critical “reset” with April’s budget. The government’s commitment to get the budget back to surplus cut through with voters and provided a sustained bounce in the Coalition’s primary vote.

The promised budget surplus also sent a message to voters that the Coalition could manage the economy, Bourke reported.

Oh dear. Bit early to be counting your chickens.

The first blow during the election campaign to the government’s confident budget forecasts of continuing strong growth came with news that the overall cost of the basket of goods and services measured by the consumer price index did not change during the March quarter, cutting the annual inflation rate to 1.3 per cent, even further below the Reserve’s target of 2 to 3 per cent on average.

Such weak growth in prices is a sign of weak demand in the economy.

The second blow was that, rather than increasing as the budget forecast it would, the annual rise in the wage price index remained stuck at 2.3 per cent for the third quarter in a row. The budget has wages rising by 2.75 per cent by next June, by 3.25 per cent a year later and 3.5 per cent a year after that.

As Lowe never tires of explaining, it’s the weak growth in wages that does most to explain the weakening growth in consumer spending and, hence, the economy overall. Labor had plans to increase wages; Morrison’s plan is “be patient”.

The third blow to the budget’s overoptimism was that, after being stuck at 5 per cent for six months, in April the rate of unemployment worsened to 5.2 per cent. The rate of under-employment jumped to 8.5 per cent.

Why didn’t Labor make more of these signs of weakening economic growth during the campaign? It had no desire to cast doubt on the veracity of the government’s budget forecasts because, just as they provided the basis for the government’s big tax cuts, they were also the basis for Labor’s tax and spending plans.

Labor was intent on proving that its budget surpluses over the next four years would be bigger than the government’s – $17 billion bigger, to be precise.

Think of it: an election campaign fought over which side was better at getting the budget back to surplus, just as a slowing economy and the limits to interest-rate cutting mean that, at best, any return to surplus is likely to be temporary.

Morrison’s $1080 tax refund cheques in a few months will help bolster consumer spending, but they’re a poor substitute for decent annual pay rises.

Read more >>

Don't trust pollies to tell you the truth about tax

"You don’t grow the economy by taxing it more,” Scott Morrison declared in the ABC’s election debate. Then his Treasurer, Josh Frydenberg, claimed the Coalition’s $300 billion in tax cuts would make income tax “more progressive” not less. As a prospective major beneficiary of those cuts, I’d love to believe both claims. Unfortunately, there’s little evidence to support either.

Meanwhile, higher income-earners should be in no doubt they’ll be paying a lot more tax should Bill Shorten and Chris Bowen come to power and get their plans through the Senate.

Labor plans to reduce the concessional treatment of negative gearing and capital gains, unused franking credits and family trusts, abandon the second and third stages of the $300 billion tax cuts, and increase the top rate of income tax by 2¢ in the dollar for three years.

If the line that “you don’t grow the economy by taxing it more” makes sense to you, you need to think harder. Taken literally, the sensible response to it is, “No one ever said you do”. It’s a non-sequitur – the first part of the sentence doesn’t fit with the last part.

Morrison wants you to think it means that taxes always discourage economic growth. This notion suits many well-off people who’d love to pay less tax, but that doesn’t make it true.

Say by some miracle we lived in a world with no taxes. It’s not clear that if we had no one enforcing laws, the roads were shocking, and only the rich could afford to educate their children or see a doctor, the economy would be much bigger and faster growing.

On the other hand, it would be true that taxes held back the economy’s growth if governments collected a lot of tax and then buried the money in a hole.

In the real world, however, governments spend almost all the money they collect in taxes (if not more). Some of that money may be wasted, but much of it does a lot of good – to the economy and the people who make up the economy.

We all benefit from living in law-abiding country, with decent roads, low-cost education and good healthcare, not to mention the high wages our educations and health enable us to earn. Our businesses also benefit from operating in such a country.

It’s true that some countries have tax systems that collect their taxes in ways that do more to discourage economic activity than other countries do. It’s true, too, that some countries spend their tax dollars more effectively than others.

But what economists have never been able to demonstrate is that those countries with high rates of total taxation – the Scandinavians, for instance – have smaller and slower-growing economies than those countries with low rates of tax.

There would be more truth in Morrison’s line if he changed it to say “you don’t grow the economy by taxing it less” – you just leave some people better off and others worse off.

Which brings us to Frydenberg’s remarkable claim that his $300-billion tax plan – where the first stage goes mainly to middle income-earners, but the two later stages go disproportionately to people earning a lot more than $100,000 a year - will make the income tax scale more “progressive” rather than less.

As I explained in detail in this column a month ago, a progressive tax is one that takes a progressively higher proportion of people’s incomes as incomes rise.

But two economists at the Australian National University’s research school of economics, Associate Professor Chung Tran and Nabeeh Zakariyya, have produced a more sophisticated analysis, using the Suits index (invented by Daniel Suits) to express our income tax scale’s progressivity as a single number, and then see how it has changed over the years.

Unsurprisingly, they find that our income tax scale is and always has been progressive (and will stay progressive if the Coalition’s tax plan comes to pass).

They found that, in 2016, the top 10 per cent of taxpayers accounted for 32 per cent of all the pre-tax income, but 46 per cent of all the income tax paid. That’s progressive. Between them, their marginal tax rate (on the last part of their income) was 41¢ in the dollar, but their average tax rate (on all their income) was just 29¢ in the dollar.

More surprisingly, the authors found that the scale’s degree of progressivity changes from year to year, and tends to move in cycles of greater and lesser progressiveness.

What factors cause these cycles? Government-initiated changes in the scale, obviously, but also changes in the distribution of pre-tax income between income-earners and – a big one – the effects of “bracket creep” as inflation pushes people onto higher tax brackets or otherwise raises their average rate of tax.

Significantly, the authors confirmed Treasury’s contention that bracket creep reduces progressivity - that is, it favours high income-earners (who don't have a higher tax bracket to be pushed onto).

They find that the income tax scale’s progressiveness declined in the Howard government years between 2001 and 2006, but then increased sharply, reaching a peak in 2010 (during the Labor years), but since then has declined slowly (thanks to bracket creep and the absence of tax cuts, as governments gave top priority to reducing the budget deficit).

Even so, the scale was more progressive in 2016 than it was in 2004.

Frydenberg’s claim that his three-stage tax plan would make income tax more progressive seems based on the fact that the top tax rate would be unchanged at 45¢ in the dollar, while some lower rates fell and, according to Treasury’s debatable projections, by 2024 the top 5 per cent of taxpayers’ share of total tax paid would have risen from 32.7 per cent to 32.9 per cent.

Should his plan actually come about, the Suits index will tell us whether it really has made income tax more progressive rather than less. Since people on $200,000 will have their average tax rate cut by 4.5¢ in every dollar of income, I very much doubt it.

Read more >>

Treasury signs off on budget fantasy forecasts

While we were preparing for the Easter-Anzac super long weekend, the secretary to the Treasury and the secretary of the Finance Department released the PEFO – pre-election economic and fiscal outlook – their official, once-every-three-years licence to tell us anything the government hasn’t told us but should have. And what was that? Not a sausage.

They made trivial updates to the budget figures and solemnly swore that all the rest of it “reflects the best professional judgement of the officers of the Treasury and the Department of Finance”. Wow. Really?

This despite the fact that, taken at face value, this is the most fiscally irresponsible budget since Whitlam. It’s a budget claiming to be able to cut income tax by $300 billion over 10 years and spend $100 billion on infrastructure over 10 years, while still returning to continuous surplus and eliminating the net debt over the same period.

No sensible person could believe all that was likely to come to pass. Far more probable that, should those tax cuts and spending increases actually happen, it wouldn’t be long before the budget was back in deficit and the debt was growing not falling.

We owe it to the Grattan Institute’s Danielle Wood and her team for joining the dots, provided in the bowels of the budget papers, to reveal how the cost of the tax cuts stays small until the last year of the budget’s “forward estimates”, 2022-23, then leaps to a cost of about $35 billion a year, rising to about $45 billion a year in 2029-30.

Never before have we had tax cuts remotely approaching such a cost.

The reason this grandiosity reminds no one of the Whitlam era is that no one takes it at face value. No one believes it could possibly happen. It’s a description of a future fantasyland.

First, it’s the budget of a chronically unpopular government desperately trying to bribe its way back to office, with little chance of succeeding.

Second, its supposed action is many years – and two or three elections – off in the future. Whatever transpires over the next decade, we can be pretty sure it won’t bear much resemblance to the scenario painted in the budget papers.

But if it’s all harmless bulldust, it can hardly reflect Treasury’s “best professional judgement” unless Treasury’s joined the happy fiction business. And the fact remains that, even more than its predecessors, this is a budget calculated to mislead.

What Treasury declines to make sure we realise is that the magic is all achieved by assumption. Convenient assumption.

Just as Wayne Swan’s promised return to permanent surplus – and his later assurance that his hugely expensive disability insurance scheme and Gonski school funding, though carefully hidden beyond the forward estimates, were “fully funded” – were based on overly optimistic assumptions that failed to come to pass, so is Josh Frydenberg’s promised return to permanent surplus and his assurance that his $300 billion in tax cuts and $100 billion in infrastructure spending are fully funded.

The trick has two parts. First, assume (as you did in each of the seven previous budgets) that, within a year or two, the economy’s growth will have returned to the old normal, where it will stay forever.

Second, assume the government will be able to sustain for many years a degree of spending restraint never achieved in the past. Make sure this heroic assumption is turned into a cabinet resolution, so it can be passed off as the seemingly innocuous assumption of “unchanged policy”, not the mere New Year’s resolution it really is.

Swan’s claim (proved by lovely graphs) that his hidden spending plans were fully funded was based on government policy to limit spending growth to 2 per cent real a year on average – a goal he repeatedly claimed to be achieving, but never did.

Frydenberg’s claim (with lovely graphs) that his post-forward-estimates tax cuts and spending increases are fully funded is based on a government policy to limit real spending growth to even less than Swan’s 2 per cent, which will cause total government spending to fall from 24.9 per cent of GDP to an unbelievable 23.6 per cent by 2029-30.

Again, we’ve had to rely on Grattan’s Wood to join the dots the budget papers don’t and tell us Frydenberg’s happy assumptions imply annual spending cuts increasing to about $40 billion a year by the final year. (She has also explained the tricks on which the government’s claim to have limited its real spending growth to 1.9 per cent a year relies.)

Meanwhile, back in the real world, the economic outlook is so strong the Reserve Bank is deciding whether it needs to start cutting interest rates immediately, or can afford to wait until unemployment starts rising.

And continuing strong growth, we’re asked to believe, is Treasury’s best professional judgement.

Read more >>

A present-laden kiss from Santa won't make healthcare better

Whenever voters are asked what are their main issues of concern, one worry always comes top: healthcare. That explains why we’re hearing so much about health in this ever-so-exciting election campaign.

Bill Shorten wants to talk about health because it’s one of the issues voters always regard as better handled by Labor than by the Coalition. (Voters habitually favour the Coalition on running the economy and on taxation, which explains why these are Scott Morrison’s favourite topics.)

But this time the Coalition’s also keen to talk about all it’s done – and is promising to do – on health because it blames Labor’s last-minute social media scare campaign – that the Libs had plans to “privatise” Medicare – for its loss of seats in the 2016 election.

The truth is, by international standards Australians have good health and a good healthcare system, which doesn’t cost all that much.

So why is healthcare always our biggest worry? Perhaps because of the well-publicised waiting times for elective surgery in public hospitals. Or because most medical specialists charge fees far higher than the Medicare benefit, with the gap paid out of the patient’s pocket.

Australia’s health system is more reliant on out-of-pocket payments than most other rich countries. Part of this is the ever-rising cost of private health insurance.

This explains why the things politicians say about healthcare during election campaigns invariably involve spending more money. Governments boast that they’re spending record amounts (which is always true because both prices and the population keep rising) and promise to spend a bit more.

This time, Labor claims the Coalition has “cut” healthcare spending – by which it means that the Coalition hasn’t spent as much as the previous Labor government had planned to – and is promising to restore that funding (mainly in the form of the feds picking up a higher share of the states’ spending on public hospitals) and to spend more on reducing the out-of-pocket costs of cancer patients.

Are you detecting a pattern here? Because the health system has long been about as privatised as it could be – private hospitals, private health insurance, subsidised fee-for-service payments to self-employed GPs and specialists, co-payments for pharmaceuticals and for doctors who don’t bulk-bill – governments can never spend enough.

As presently organised, our system is a bottomless pit. Governments could never satisfy the demand that doctors and hospitals could generate if left to their own devices.

When you add federal and state, healthcare is by far the biggest and the fastest growing category of government spending – and thus the biggest reason we need to pay more in taxes each year.

It’s also our fastest growing employer. It’s certain to keep growing rapidly, not only because of the ageing population but also the ever-rising cost of advances in medical technology.

This isn’t bad, it’s good. The richer we get, the more we can afford to spend on top-quality healthcare. But that’s not to say we couldn’t be getting much better value for the dollars we spend.

Because our present badly organised system is driven mainly by doctors’ – particularly specialists’ - desire to protect and increase their incomes, whichever side of politics is in office, federal or state, spends most of its time between elections trying to hold back the growth in health spending.

They do this mainly by crude methods such as allowing backlogs and waiting lists to build up, freezing the level of Medicare rebates, increasing patient co-payments and delaying the approval of new pharmaceuticals.

Then, when an election looms, they approve a raft of new drugs, promise to spend more on a few things chosen to appeal to voters, and to spend $X million shortening surgery queues which, for some mysterious reason, seem to have built up.

That is, at elections both sides play Santa, not Mr Fix-it. Any plan to reform something would be bound to have some brand of specialists howling for your blood, and conning old ladies into monstering their local member.

In consequence, progress in reducing waste and improving the quality of care is slow. Doctors earn their living by fixing people who are sick. There’s little incentive to do what makes more sense: divert more of the spending into encouraging people to avoid getting sick in the first place.

After that comes more emphasis on early detection: better for the patient, better for the taxpayer. And the best way to improve prevention and early detection is to divert more money into “primary care” – by GPs and other health professionals, such as specially trained nurses, physiotherapists, psychologists etc.

GPs need to be shifted from providing acute care – charging a fee every time someone turns up for a consultation – to receiving larger payments from the government for accepting responsibility for helping a particular patient deal with a particular chronic condition, such as diabetes, for a period of time.

The Coalition’s record in making progress towards such a better, more integrated system is, at best, mixed.

The parts of Labor’s policy it doesn’t want to talk about – setting up a federal-state Australian healthcare reform commission – and the specifics of how it would keep its promise to encourage cancer specialists to bulk-bill, hold the promise of systemic improvement. But also the risk that the extra spending did more to help specialists' pockets than patients'.

Read more >>

Strong economy? No, but maybe it will be eighth time lucky

Scott Morrison wants the Coalition re-elected because of its superior management of the economy. In Josh Frydenberg’s budget speech he referred to our “strong economy” 14 times. Why? He had to keep saying it because it ain’t true.

But get this: it’s not the government’s fault. It’s happening for reasons far beyond the government’s control. Growth is weak in Australia and throughout the developed world for deep reasons economists don’t yet fully understand.

It’s taken a while to realise this because the econocrats – mainly Treasury, but with the acquiescence of the Reserve Bank - either can’t or won’t accept its truth. They’ve gone for eight budgets in a row forecasting an early return to strong growth.

And for seven years in a row they’ve been way off. But so great is their certainty that nothing fundamental has changed, they’ve fronted up with yet another forecast that this year will be different. This year we'll reach lift-off.

It may not be entirely coincidental that, the longer Treasury dwells in the land of hope-springs-eternal, the more it gives its political masters the budget numbers they crave: ones showing the budget deficit soon returning to surplus and staying in surplus as the net debt falls to zero.

In what follows, I’ll ignore Treasury’s cute distinction between “forecasts” and “projections”. Sorry, guys, you’ve played that card too many times.

It’s a key part of the way you’ve misled the public, your political masters, economists and probably even yourselves, that everything’s going fine and will soon be back to normal. It’s part of the reason the net debt’s been allowed to double under this government – we kept being told it wasn’t happening.

When laughing-stock Wayne Swan began his 2012 budget speech promising four budget surpluses in a row, this was based on Treasury’s forecast that real gross domestic product would grow by 3.25 per cent in 2012-13, and then by 3 per cent in each of the three following years.

The 3.25 per cent turned out to be 2.6 per cent, then another 2.6 per cent, 2.3 per cent and 2.8 per cent.

After such an embarrassing stuff-up, you’d think Treasury might have had a rethink. Not a bit of it. Just two budgets later – this government’s first - it had the economy’s growth accelerating over the forward estimates not to 3 per cent, but 3.5 per cent. The first of these turned out to be 2.3 per cent and the next one, 2.8 per cent.

In the 2016 budget, Treasury took a bit of a pull and reverted to forecasting recoveries to no more than 3 per cent growth.

In this month’s budget, Treasury has us growing by only 2.25 per cent in the year just ending. But not to worry. In the coming year it will strengthen to 2.75 per cent, and be back to 3 per cent in the second last year of the forward estimates, where it will stay in 2022-23.

It’s a similar story with what’s become the key problem component of GDP, wages. In Swan’s ill-fated budget, the wage price index was forecast to grow by 3.75 per cent in the budget year and the year following. Turned out to be 2.9 per cent and 2.5 per cent.

The following year’s budget – Swan’s last – put expected wage growth in 2014-15 at 3.5 per cent. Turned out to be 2.3 per cent. Treasury’s first guess for 2017-18 was 3 per cent. Came in at 2.1 per cent.

Treasury’s response to its repeated over-forecasting is just to push the ETA of the return to strong growth out another year. Nothing fundamental in the economy has changed, nothing’s wrong with the forecasting method, it’s just taking a bit longer than we thought. This time we’ll be right.

But, you may object, if the economy’s remained so weak for so long, how come growth in employment has been strong since early 2017 and unemployment has slowly fallen to 5 per cent?

Because of high levels of immigration – high even by our standards, and unmatched by the other rich countries – and because the under-employment rate was worsening until recently.

Much of the jobs growth has come from federal government spending on rolling out the National Disability Insurance Scheme, and state government spending on infrastructure. After all, public sector consumption and investment spending accounted for more than half the surprisingly weak GDP growth of 2.3 per cent over calendar 2018.

Remember this: a strong, healthy economy is one where demand is always threatening to push inflation above the target zone. Our inflation rate's been below the target for three years.

And this amazing fact: the world real long-term interest rate has been falling for years and is now at zero or below. That’s a sign of strong growth?

It’s time Treasury and the Reserve stopped kidding themselves – and us.

Read more >>

Morrison plan shows who he thinks most deserves a tax cut

Scott Morrison wants this election to be all about his redoubled plan for lower taxes. But Treasurer Josh Frydenberg doesn’t want anyone saying it will stop income tax being “progressive”. He’s right. But his claim that the tax system will remain highly progressive is debatable.

In last year’s budget, Morrison announced a three-stage tax cut, spread over seven years. It had a cumulative cost to the government’s revenue of a massive $144 billion over 10 years, with most of that cost coming in the later years.

In the budget Frydenberg produced last week, he doubled down on last year’s plan. He doubled the early part and greatly increased the later parts, at an additional cost of $158 billion over 10 years, taking the total cost to more than $300 billion – an incredible sum in several senses.

I’ll explain the grand plan in a sec, but first let’s be clear on the meaning of three words you hear bandied about whenever tax changes are debated: progressive, regressive and (less commonly) proportional.

A tax is said to be progressive when it takes a progressively higher proportion of people’s income as incomes rise.

The key word here is proportion. You judge “progressivity” not by the dollar amount people pay, or the amount of the cut they get, but by how that amount compares with their income. When a tax takes a higher proportion of a higher income than it does of a lower income, it’s progressive.

Conversely, a tax that takes a higher proportion of lower incomes than it does of higher incomes is said to be regressive.

A tax that takes the same proportion of all incomes, whether high or low, is said to be (you won’t believe this) proportional. It marks the borderline between progressivity and regressivity.

The main progressive tax is personal income tax. The example of a regressive tax people always quote is the goods and services tax.

But, in fact, almost all other taxes are regressive – with the notable exception of tax on the value of land (such as council rates), which is progressive because people with high incomes tend to own more land and more valuable land.

What makes income tax progressive is that your income is taxed in slices, with each extra slice being taxed at a higher rate.

Under the present tax scale – which Morrison’s plan would change in coming years – the first $18,200 of your income goes untaxed, the next $18,800 is taxed at 19¢ in the dollar, the next $53,000 at 32.5¢, the next $90,000 at 37¢, and anything above that at 45¢ in the dollar. (All of which is before you add 2¢ in the dollar for the Medicare levy.)

The slice (or tax bracket) into which the last part of your income falls determines your “marginal” tax rate – the rate you pay on any increase in your income.

Your average tax rate is determined by adding up all the tax you pay on each slice, then dividing that total by your income. Your average tax rate will always be a lot lower than your marginal rate.

For an income tax to be proportional it must have only one rate and no first, tax-free slice. So any income tax scale with a tax-free threshold must be progressive, even if only mildly so.

Now the details of Morrison and Frydenberg’s grand plan. As I said, it cuts tax in three stages over seven years.

The first is an immediate, reasonably generous tax cut (equivalent to about $20 a week) to people on middle incomes, earning between $48,000 and $90,000 a year. Those below that range get a lot less, as do those above it.

The second stage, which comes in three years’ time, July 2022, offers nothing much for people earning below $90,000 a year. For those earning more, there’d be a new tax cut ranging from nothing to $26 a week for those on $120,000 and above.

The third stage, coming a further two years later, in July 2024, offers tax cuts for everyone earning over $45,000 a year, ranging from nothing to about $65 a week for those on incomes up to $180,000 a year – plus another saving of up to $58 a week for those earning up to $200,000 and above.

But here’s a tip. You can think of the first, immediate stage as almost certain to be received because, though it has been only partially legislated, Labor has pledged to put it through.

It’s uncertain, however, whether we’ll ever see the other two stages. It’s not just that they’re so far into the future. It’s also that, though last year’s stages two and three are legislated, Labor says it would repeal them. As for this year’s enhancements of stages two and three, they're not yet legislated, and Labor won’t have a bar of ’em.

But, assuming stages two and three actually come to pass, how would the plan change the tax scale’s progressivity?

Well, with marginal tax rates varying from zero on income up to $18,200 a year, to 45¢ in the dollar on income over $200,000 a year, there can be no doubt that income tax would remain progressive.

But Frydenberg’s claim it would remain “highly progressive” is debatable. Presumably, he bases this on the estimate that the top 6 per cent of taxpayers, those earning more than $200,000 a year, would still be paying 36 per cent of total income tax collections in 2024-25.

Given the (no doubt optimistic) assumptions about how fast wages grow between now and then, this may be arithmetically correct. But it ignores the way the introduction of a massive 30¢-in-the dollar tax bracket running from $45,000 a year to $200,000 would put a big kink in the tax scale, making it significantly less progressive than it was.

The proof: whereas people on incomes between $45,000 and $90,000 would have their average tax rate cut by about 2.5 percentage points, this then rises to a cut of 4.8 percentage points for those on $180,000, before jumping to a maximum cut of 5.8 points for those on $200,000 and above. It’s tough at the top.

Read more >>

Why politicians only pretend to care about low income earners

It must be the Salvo still hidden inside me that makes my blood boil when Treasurer Josh Frydenberg claims to be delivering a tax cut worth $1080 a year to “low and middle income earners” and his claim is mindlessly repeated by journalists as though it’s a fact that doesn’t need checking.

I was brought up to care about people at the bottom. So, since we’re bound to spend most of the election campaign debating the complaints of the whingeing well-off, let’s spend just a moment thinking about “those less fortunate than ourselves”.

The $1080 – which Labor has promised to match should it win the election – will go to people earning between $48,000 and $90,000 a year, or about $920 to $1730 a week.

Does that sound like low and middle to you? It’s not hard to convince yourself it does. After all, the average earnings of adults working full-time are $93,300 a year.

Trouble is, the average (or mean) income is far from being typical. That’s because it’s pushed up by a relatively small number of people on very high incomes - the 1 per cent, if you like.

The typical income isn’t the mean, it’s the median – the one that, if you arranged all the incomes by size, is exactly in the middle, with 50 per cent of incomes above and 50 per cent below.

The median adult full-time worker is on $78,300 – 16 per cent lower than the mean. What makes the median “typical” is that a high proportion of all full-time workers will be clustered around it, a bit above or a bit below.

But about a third of all workers are part-time, two-thirds of whom are women. Shouldn’t they be included in any assessment of what’s “low and middle”?

When you do include them, the typical income of all workers drops to $57,900. That’s 21 per cent above $48,000 and 36 per cent below $90,000. So the government’s range does a better job of covering those above the middle than those below.

But how low is low? It’s hardly true that there are no workers on incomes below $48,000. Not even full-time workers. The federal minimum full-time wage is $37,400. How can anything called a “low and medium income” tax cut fail to include the many full-timers on the minimum wage?

It’s true, of course, that not everyone earning less than $48,000 a year misses out on a tax cut (known technically as a tax offset). Those earning $37,000 get not $1080 a year, but $255 – about a quarter of the full cut.

Why? Presumably, because their incomes are too low to qualify as officially low. Or maybe because, when your income’s that low, your need for a bit more money to spend is even lower. They might go crazy if you gave them as much as a thou.

For incomes between $37,000 and $48,000, the tax cut starts at $255 and rises at the rate of 7.5¢ in the dollar until it reaches $1080. This means those on the minimum full-time wage get a princely $285.

For incomes below $37,000, the tax cut will be up to $255 – though, for such an insignificant group, a mere 2.3 million people, the budget papers don’t bother saying how this will work.

Is that the bottom of those with low income incomes? Not really. About a third of households have incomes too low to pay income tax. Some of these people are the comfortably off alleged “self-funded retirees”, whose income from superannuation is exempt from income tax, but the rest are people dependent on some form of government welfare payment.

What do they get? Those on some form of pension get a one-off payment of $75 (or $125 for couples), which will be a huge help with their power bills.

What gets me is how we can claim to be worried about those with low incomes while excluding those whose income is low because they can’t find a job. They were ineligible for help because the lower taxes were only for, to quote the measure's official name, “hard-working Australians”.

Longing to be a hard worker doesn’t qualify, apparently. Frydenberg went to great length to justify the decision to exclude those on the dole even from the $75 payment – before the government belatedly included them, for fear the measure might be blocked in the Senate.

But if anyone really cared about the lowest of low incomes, they’d end the 25-year freeze on increasing the dole beyond the rise in consumer prices. It’s unconscionable for a nation as rich as we are to the give the jobless so little to live on it actually makes it harder for them to find work.

And that’s before you remember all the many instances where this government has sought to stigmatise and punish the unemployed for being jobless. For the jobless, it's all stick, no carrot.

Don’t kid yourself Labor would be much better, however. It’s seeking plaudits (and product differentiation) by raising the Liberals’ $255 cut to $350 – which will make all the difference.

And Labor is just as unwilling to increase the dole as the Coalition is. Why? Not because Labor thinks it possible to live decently on $40 a day, nor even because it would cost too much (which it wouldn’t).

No, as Labor shadow social services minister Linda Burney had the honesty to admit, it’s because too many voters – including Labor voters, no doubt – would disapprove. And we wouldn’t want that.

Read more >>

Frydenberg's budget: if it looks too good to be true . . .

What a wonderful world we live in now our politicians have discovered the cure for opportunity cost. In his first budget, Josh Frydenberg is doing a Gladys: he wants us to believe “we can have it all”.

Over the next 10 years, he can give us: tax cuts worth $302 billion, new infrastructure worth $100 billion, sundry other goodies, and a budget that’s back in the black and stays there, so that the net debt falls to zero. Yeah? How?

But first, a flashback. Labor’s Wayne Swan ended up a laughing stock after he began his 2012 budget speech with the immortal words: “The four years of surpluses I announce tonight . . . this budget delivers a surplus this coming year, on time, as promised, and surpluses each year after that, strengthening over time.”

Here's what Frydenberg said seven years later: “Tonight, I am pleased to announce a budget surplus of $7.1 billion . . . In 2020-21, a surplus of $11 billion. In 2021-22, a surplus of $17.8 billion. In 2012-23, a surplus of $9.2 billion. A total of $45 billion of surpluses over the next four years.”

Oh dear. This year even the media knew not to fall into their usual trap of treating the government’s estimate of next year’s budget balance as an already accomplished fact. Actually, we won’t know the “actual” for another 18 months.

But, as usual, the media took little notice of the expected budget balance for the year just ending – a truth the Finance Department’s creative accountants have long exploited to improve the new year’s expected balance at the expense of the old year’s.

Some have questioned why Frydenberg didn’t try harder to turn the old year’s small deficit into a small surplus so that, should the Coalition lose the election, it would have avoided going into the history books as a government that was in power for six years without ever recording a surplus.

Short answer: it couldn’t afford to. Reading the budget papers’ fine print makes it clear the creative department had to put in much furniture shifting to come up with the predicted surplus of $7.1 billion – an amount Frydenberg has been able to assert is “substantial” rather than “wafer thin”.

Think about this: in the old year, government spending is expected to leap by 4.9 per cent in real terms, whereas in the new year it will grow by just 0.1 per cent real. Do you reckon that discontinuity happened by chance?

My colleague Shane Wright has noted the government’s decision to bring forward to the old year $1.3 billion in grants to local councils due to be made in the new year. He could have added that two new one-off cash grants, one to help recipients of residential aged care and another to help pensioners with their energy bills, with a total cost approaching $700 million, will be paid in the old year rather than the new.

The government’s been promising to have the budget “back in the black” by 2019-20 since Joe Hockey’s time. And for some years has been “reprofiling” the timing of payments and receipts to ensure this target is met.

Wright reminds us that a change in the timing of tobacco excise collections announced in last year’s budget will, purely by chance, yield a one-off boost of several billions in the new financial year.

Why are we so anxious to get the budget back in black? Because we want to start reducing the government’s debt. Trouble is, since Peter Costello’s day, successive treasurers have drawn our attention to the underlying cash deficit and away from the ironically named “headline” cash deficit.

That’s a problem because it’s actually the higher headline deficit that has to be funded by borrowing – or, if it’s in surplus, can be used to pay off debt. Guess what? The budget estimates that we’ll still be in headline deficit of $4.4 billion in the coming year, and won’t be in surplus until 2021-22.

The discrepancy is explained mainly by successive governments using an accounting loophole to exclude their spending on the NBN, the second Sydney airport, the inland railway and other projects from the underlying deficit.

Even so, Frydenberg assures us the government’s net debt will have been fully repaid by June 2030 – and he has a lovely graph that proves it. How is our path to a debtless Nirvana achieved?

By assuming that government spending grows with almost unprecedented slowness despite the ageing of the population, that the economy grows strongly for another 10 years without missing a beat and with productivity improving each year at a rate faster than we’ve achieved in decades, and – get this – that the government’s financial assets will grow by almost 3 percentage points to 12.8 per cent of gross domestic product.

When it comes to creativity, Australia’s politicians are second to none.

Read more >>