Just about everything happening in the economic world at present is premised on the early return of the resources boom. If so, it won't come a moment too soon for the growth fiends: this week's national accounts show the economy losing momentum in the March quarter.
The imminent resumption of the boom explains why the Reserve Bank has been so keen to get interest rates back to normal levels, why the government is expecting to have the budget back in surplus in three years and, indeed, why it thinks now's a good time to reform the mining industry's royalty payments.
But the boom ain't back yet. To the contrary, the accounts show the economy growing by 1.1 per cent in the December quarter, then slowing to 0.5 per cent in the latest quarter. Those figures probably exaggerate the extent of the slowing - it's a mistake to take quarter-to-quarter changes in the accounts too literally.
Even so, what stands out is the economy's continuing dependence on the rapidly withdrawing fiscal stimulus. So if you think the stimulus was unnecessary or all a terrible waste or that the government should be winding it back much faster than it is, think again.
By far the greatest single source of growth during the quarter was government spending, which contributed 0.9 percentage points to the increase in gross domestic product. Within this, real capital works spending by the federal government grew by 15 per cent and that by the states by almost 17 per cent.
Much of that would be stimulus-related spending on public infrastructure but a fair bit would be the school-building program. Sections of the press have worked overtime to give an exaggerated impression of this program's wastefulness.
I don't doubt there has been some waste and that's regrettable. But the fearless campaigners never acknowledge (and probably don't understand) the macro-economic imperative to get the money spent as quickly as possible so as to limit the rise in unemployment and stop the economy dropping into a downward spiral.
It's all very well banging on about the waste of taxpayers' money but unemployment is also a waste. It's a waste of the time idle workers could have contributed to the nation's production.
Though the principal loss is borne by the jobless workers (who gives a stuff about them?), there's a cost to all of us - plus, of course, a cost to the budget in unemployment benefits and tax revenue forgone.
When workers are jobless for long periods they suffer a lasting loss of skills, confidence and motivation, which is also a loss to the community. And when high unemployment scares consumers into cutting their spending and causing yet more unemployment, otherwise-sound businesses go bankrupt and are broken up, destroying capital at a direct cost to the businesses' owners and an indirect cost to all of us.
So the next time you read another allegation of wastefulness (with no mention of the great majority of successful projects), think of all the costs and waste that would have occurred had the money not been spent. (It remains an inconvenient truth that even wasteful spending stimulates activity and helps avoid unemployment.)
Back to the national accounts. The only other significant positive contribution to growth in the quarter came from the lacklustre rise of 0.6 per cent in consumer spending. The $900 cheques are a distant memory.
But against these positive contributions are two main negatives. Business investment spending subtracted 0.5 percentage points from real GDP, with non-dwelling construction down 2.5 per cent and spending on machinery and equipment down 6 per cent (after being up 10 per cent the previous quarter).
Ah. More evidence of the fiscal stimulus - or rather, the absence of it. Business spending on plant was way up in the December quarter because that was the last quarter of the special tax break. It was way down in the March quarter because many businesses had brought their spending forward to take advantage of the special offer.
The other negative contribution was external. The volume of exports fell by 0.5 per cent (mainly due to a fall in coal exports caused by cyclones in Queensland) while the volume of imports increased by 2 per cent. Together, these subtracted 0.5 percentage points from GDP.
It's clear the fiscal stimulus is having conflicting effects on the economy. The programs that have wound up are subtracting from growth while those still going are adding to it. According to Treasury, the net effect is a subtraction from growth in the quarter of 0.1 percentage points.
Just think how much weaker the quarter's growth would have been had the government yielded to the opposition's calls for the stimulus spending to be cut off earlier than planned.
It would be wrong to conclude, however, that the accounts showed no sign of a returning resources boom. The terms of trade - the ratio of export prices to import prices - improved by 4 per cent, their third successive quarterly advance.
Clearly, the prices we're getting for our mineral exports are rising and this was also evident in the $2.2 billion turnaround in the trade balance for the month of April.
Whereas real GDP grew by only 0.5 per cent in the March quarter, the improvement in the terms of trade meant real gross domestic income grew by 1.3 per cent. Over the past three quarters, real GDI grew by 3.5 per cent, as against growth in real GDP of 1.9 per cent. This is an early indicator of stronger consumer spending on the way.
And although business investment spending was weak in the March quarter, we know from surveys there's huge spending in the pipeline, particularly mining and natural gas projects.
Last quarter the economy was betwixt and between but, never fear, the boom is returning (the big miners' callous brinkmanship over taxation notwithstanding).
Talk about a two-track economy. Have you noticed how the government and others have been focused on the return of the resources boom, with all the tax bonanzas and challenges that could bring, while the rest of the world has been worrying itself sick about the debt problems in Europe, sending our sharemarket and the Aussie dollar tumbling?
Surely the two don't fit. Are we living in fantasyland? Is reality about to hit us on the head? Or could it be that Europe's problems don't have all that much to do with us and before long the global financial markets will stop panicking and our share prices and currency will recover?
Standard product warning: no one knows what the future holds and economists aren't good at predicting it. But my guess is the end of our world isn't nigh.
Although the Greek government was in over its head even before the global financial crisis reached its peak in late 2008 (and was fudging its figures to hide the truth), most of the other European governments now have big budget deficits and huge levels of debt because of their efforts to rescue their banks and their heavy spending to stimulate their economies.
Those national governments with rocky banks (including the United States) have, in effect, transferred their banks' debt on to their own books. So what started as excessive private debt is now excessive public debt.
I don't criticise them for this. Had they not rescued their banks the outcome would have been a lot worse. No, the real problem is that, unlike us, their affairs weren't in order before the crisis. They'd been running budget deficits even in the boom years and had high levels of debt even before they were obliged to borrow so heavily.
The particularly acute problems in Greece served to draw the attention of the world financial markets to problems in other countries - Portugal, Spain, Italy and Ireland. Even the Brits have huge debt levels.
As often happens, the markets flipped from inattention to panic. When they're in that sort of mood, all the news is catastrophic. The Chinese had jammed on the brakes to burst a property bubble, putting an end to the global recovery. The Australians had nationalised their mining industry (something like that, anyway; not sure of the fine detail).
Whenever the players in world financial markets are gripped by panic their tendency is to sell whatever shares they can wherever they can and buy US Treasury bills. Even when it's the US economy that's at the heart of the problem, they still do it.
The result is a fall in sharemarkets around the world and a rise in the value of the US dollar at the expense of most other currencies. If you remember, this is what happened after the collapse of Lehman Brothers. Our dollar went from US98 in July 2008 to US63 in November. It stayed there until March, then eventually climbed back to US92.
The likelihood is that, as the present panic subsides, our share prices will recover and our dollar will go back up (as it has already begun to). But this return of the staggers is a reminder that a lot of the underlying problems exposed by the global financial crisis are still with us, and will be for a long time.
So perhaps the recovery of sharemarkets in the months following the crisis was a bit too optimistic and this time it won't be as strong.
Certainly, the Europeans won't easily dispense with their debt problems. And the more they feel pressured by the markets to turn around their budget balances by slashing government spending and raising taxes the more they'll slow the recovery in their economies.
The Europeans' problems are compounded by the existence of the euro currency arrangement, and their efforts to hold it together may end up extracting a high price in terms of economic growth. All the troubled member-countries would be better off being able to set their own interest rates and allow their own currency to fall against those of their stronger European trading partners, but
they can't.
The Greeks are so deeply in hock their best solution would be to default on their debt and start again, but that isn't possible. Even leaving the euro would be terribly messy.
So Europe isn't likely to show much growth for the rest of the decade. But this won't hold Australia back as much as it would have in the old days. Our fortunes are now much more aligned with those of China, India and the rest of developing Asia. Are they likely to be adversely affected by Europe's troubles? My guess is, a bit but not a lot.
China's efforts to deal with its property bubble are quite circumscribed, so I don't expect its growth to suffer too much. If so, our authorities' expectations of a return of the resources boom aren't likely to be too far astray.
The thing about financial markets is they make judgments in haste and repent at leisure. If it's right that the prospects for our economy haven't been greatly impaired by the problems of the Europeans and the fine-tuning of the Chinese, eventually our strong position relative to the other developed economies will again be reflected in our higher share prices and exchange rate.
As ever, the ups and downs of the sharemarket will prove an unreliable guide to the prospects for the economy (even though the innocent souls who write headlines sometimes seem to imagine the sharemarket is the economy).
Similarly, the headline-writers' assumption that a fall in our dollar is an unmitigated evil says more about their innocence of economics than their grip on reality.
On this I'm with our farmers, manufacturers, tourist operators and education industry in hoping the dollar's return to the 90s takes as long as possible. There's more to life than overseas holidays.
Look at America and Europe and it's clear Australia has benefited hugely - in a material sense, at any rate - from the painful micro-economic reforms of the 1980s and '90s.
Look at our performance in the noughties, however, and it's clear the momentum of reform has dissipated. You see that in the business community's unrelenting white-anting of Kevin Rudd's emissions trading scheme, which ended in a bipartisan rejection of the use of "economic instruments" (putting a price on carbon) to combat climate change.
You see it now in the mining industry's bitter resistance to Rudd's latest attempt at major micro-economic reform, the replacement of inefficient mineral royalties with the far more efficient super profits tax.
The big miners - particularly BHP Billiton and Rio Tinto - are doing all they can to break the back of this measure, if not kill it. The newer and smaller miners, which would benefit most, seem cowed into silence.
The big boys' first success has been the opposition's - the Liberal Party opposition's - decision to again set its face against an economic-rationalist reform, one almost all economists endorse as good policy.
Professor Ross Garnaut believes the decision the nation takes on the reform of mineral royalties will either "confirm the descent of Australian political culture into a North Atlantic malaise, or represent a revival of the capacity of the Australian polity to take positions in the national interest, independently of sectional pressures".
Just so. The big miners are doing what all sectional interests attempt to do in these circumstances, persuade you and me that their problem (the government wanting to take a bigger bite out of their profits) is actually our problem (the miners will take their money elsewhere and leave us to rot).
To this end they're using a host of high-sounding, but actually unconvincing, arguments, the first of which is that the planned change in the royalty arrangements has greatly increased Australia's "sovereign risk" in the eyes of miners.
This is over the top. The sovereign risks faced by foreign investors in many countries - mainly developing countries - constitute things like having your company expropriated by the government, a breakdown in the rule of law, or the government defaulting on its debt.
Are BHP and Rio seriously putting us in that company? Turns out their definition of sovereign risk is merely "do you trust the government not to change the rules?" And what rule would that be? The price at which we're prepared to sell them our non-renewable resources.
The contract price of iron ore has increased by a factor of more than six since 2004. The contract price of hard coking coal has more than quadrupled. Do you reckon we're going to be the only country putting up the price it charges?
Far more likely that a lot of countries follow our example - which may well be what's adding extra vehemence to the big miners' fightback.
And name one country that's prepared to give foreign investors a guarantee it won't at some stage decide to change a tax or other law affecting those investors' businesses. If that's your definition of sovereign risk then it's a risk you face in every country - and many of them would be a lot rougher about it than us.
What's more, if that's sovereign risk, the only answer to it is national governments promising to give up their sovereignty. This is silly stuff.
It's curious that BHP and Rio, which purport to be so offended when anyone calls them foreigners rather than Australian, keep on about sovereign risk. Sovereign risk is the perspective of an outsider, not a local. A company with no loyalties, prepared to go wherever in the world it can get the best deal.
Every Australian business, big and small - and every individual, for that matter - faces the continuous risk that one of our nine governments will "change the rules" in ways we consider contrary to our interests.
We don't like it but, for the most part, we accept it. One of the rules that doesn't change is that democratically elected governments retain the right to change the rules. How else could you run a country?
Allied with the sovereign risk argument is the claim the resources tax would be "retrospective". This, too, is an abasement of the term. A true retrospective change involves subsequently declaring an act that was legal at the time it was undertaken illegal. That's what John Howard did with his outlawing of the bottom-of-the-harbour tax scheme.
Similarly, it would be reasonable to say a decision to change the tax on income earned (or minerals mined) before the announcement of the tax change was retrospective. But these guys are claiming a decision to increase the price of the minerals we sell them in the future - of which we're giving them more than two years' notice - is retrospective.
Huh? Apparently, any change to a mining project that's already established is a retrospective change. Had we known you were going to do this we might never have dug the mine. Yeah sure. Nor did you know the world price of the mineral was going to quadruple or sextuple in six years.
This is silly stuff. If that's your definition of retrospective, then every tax change (or other change) affecting every existing Australian business (and every person already born) is retrospective and thus improper.
As Professor John Freebairn of Melbourne University has said, "the idea that government cannot take actions that create losers ... would have stood in the path of tariff reform and most of the micro-economic reform of the past 20 years".
And if we let the big miners' pleading dissuade us from going ahead with this reform we'll be going the same way as the morally corrupt US Congress and the effete Europeans.
In the Rudd government's battle to make the mining companies pay a more reasonable price for their use of the nation's non-renewable resources, any number of dubious arguments are being thrown around.
One is the furious debate over how much company tax the miners pay. Another is the claim it was the mining industry that saved Australia from recession. The first is a red herring; the second is the opposite of the truth.
As you may have seen from the Minerals Council's full-page ads, the government has produced figures from a range of sources showing the mining industry's effective rate of tax is somewhere between 13 per cent and 27 per cent of its profits.
But the industry has produced figures from a different source that say its effective rate of tax is 41 per cent.
What are we to make of this? The figures differ because they're from different years and come from different sources using differing definitions of "tax" and "profits". If you've never before seen the same animal measured in different ways, welcome to the complexity of the real world.
The point to note is that most of these figures add together two things under the heading of "tax": the company tax the miners pay plus the royalties and other resource charges they pay.
One small problem: how much company tax the miners pay is little more than a debating point. The real issue is how much they're paying in royalties.
All companies have to pay tax on their taxable income at the rate of 30 per cent. If the amount of company tax they pay comes to a smaller percentage of their published accounting profit - as it almost always does - the explanation is that the taxman is giving them more concessional tax deductions than they use when preparing their published accounts. (It shouldn't surprise you that many companies aim to minimise their taxable income while maximising their accounting profit.)
The miners' "effective" company tax rate will usually be a lot lower than 30 per cent - and a lot lower than paid by many other industries - because mining is so capital-intensive and because the government gives them generous rates of depreciation on their equipment and structures.
So there are good reasons for miners' effective rates of company tax to be low. Is this relevant to the debate about the resource super-profits tax? Not really - unless your purpose is to bamboozle people who aren't accountants.
What is relevant is to understand that when you add company tax to royalties you're adding apples to oranges. Why? Because, although royalty payments for the use of minerals are labelled as taxes, they're not really taxes.
A tax is a payment you make to government for which you get nothing specific in return. Mineral royalties are payments miners make to government for which they get the right to take the Crown's minerals out of the ground and sell them to their customers.
Often, royalties are set at the rate of
$X per tonne. The more tonnes you take, the more you pay. So royalties are cost of production.
The rationale for the misleadingly named resource super-profits tax is that it will replace the present mineral royalties charged by state governments, which are both unfair and inefficient. They're unfair because the owners of the minerals - you and me - are getting a price for them that's now much lower than they're worth.
They're inefficient because they make no distinction between mines with high extraction costs and those with low costs, meaning they discourage mining activity that would otherwise occur.
The beauty of the new resource tax is that it charges miners for the minerals they use on the basis of the profit they're making. When world commodity prices are high the charge will be high; when world prices are low the charge will be low. And mines with high extraction costs will pay less than those with low costs. This will do much less to discourage mining.
So in demonstrating the case for a new way of charging for our minerals, it is relevant to look at how royalties have changed relative to profits since the start of the resources boom.
Figures prepared by Treasury show that over the five years to 2003-04, royalty payments averaged 32 per cent of profits. By 2008-09, however, this had slipped to 14 per cent. Using the source preferred by the Minerals Council, its figures imply the miners' royalty payments in 2007-08 were 13.5 per cent of profits - little different.
Clearly, as world prices rose the increase in royalty payments fell far short of the increase in profits. The miners received a windfall, but this wasn't shared with the owners of the resources now so much more valuable.
In BHP Billiton's full-page ad it claims the strength of our resources sector "was a key factor in keeping Australia out of recession". It offered no figures in support of this claim, so let's look at a few.
The mining industry accounts for less than 7 per cent of gross domestic product and, because it is so capital-intensive, only 1.6 per cent of our total employment. So for such a small part of the economy to have saved us its performance would need to have been miraculous.
In fact, mining contracted more than most. After peaking in the December quarter of 2008, its new capital expenditure fell in each quarter of 2009, taking the total fall over the year to almost 13 per cent.
Over the year to last September, employment in the mining industry fell by 5.6 per cent. Employment in the related heavy and civil engineering construction industry fell by 7.6 per cent. Over the same period, total employment in Australia fell by only 0.3 per cent.
In the first six months of 2009, the mining industry shed more than 27,000 workers. Had all industries behaved the same way (and assuming no fall in the rate of participation in the labour force) the unemployment rate would have increased from 4.6 per cent to 19 per cent in just six months.
This huge volatility in the mining industry - its vulnerability to swings in world commodity prices - demonstrates why, taken overall, the industry would be much better off under the more flexible royalty arrangements offered by the resource super-profits tax.
Right now, however, the tax would take a big bite out of the profits of the established mining giants, particularly BHP Billiton and Rio Tinto. That's why we're hearing so much nonsense from them.
Economics and Business Educators annual conference, Bankstown, Friday, May 28, 2010
This talk has been billed as an update on fiscal and monetary policies, but now I’ve seen the budget I want to focus in on just one development, the most interesting aspect of the budget, the Rudd government’s tax reform package - its mini reform package. This year the budget was announced in stages and the government’s response to the report of the Henry tax review was unveiled a bit more than a week before the budget - though some elements of the response were announced in the budget itself. Either way, it’s now clear that the tax package was main measure in the budget.
Contents of the package
The package consists of one big new tax, the resource super-profits tax, which will cover the cost of various tax cuts and increased tax concessions. The resource tax effectively replaces the states’ various royalty charges for the use of minerals owned by the Crown. Although the states will continue to charge these royalties, miners will have their payments refunded by the feds. The resource tax is expected to raise a net $9 billion in its first full year of operation.
Proceeds from the resource tax will finance a range of tax reductions:
• Company tax rate phased down from 30 pc to 28 pc
• Small business receives company tax rate cut earlier than other companies, plus instant write-off of new fixed assets worth less than $5000
• The present tax deduction for resource exploration costs will be turned into a ‘refundable tax offset’ at the prevailing company tax rate, making it more valuable to explorers and much more expensive to the government
• The concessional treatment of superannuation is made more concessional in several ways, including: the 15 pc contributions tax for people earning up to $37,000 a year is effectively eliminated and the higher cap on contributions by people over 50 will be continued permanently for those with inadequate super. The package will also cover the cost to revenue of the decision to slowly phase up the compulsory contribution rate for employees from 9 pc to 12 pc between 2013 and 2019. (The cost to revenue arises because wages that formerly would have been taxed at the employee’s marginal rate will now be taxed at the 15 pc rate of the contributions tax. The legal incidence of the increased contributions falls on the employer, but economists believe it is shifted to the employee by means of wage rises that are lower than otherwise.)
• Tax on interest income will be subject to a 50 pc discount (similar to the tax on capital gains) up to a limit of $1000 interest income.
• As a step towards simplifying tax returns, rather than itemising their work-related expenses (and tax agent’s fees), people may opt to claim a standard deduction of $500, to be raised to $1000.
As well as these tax measures, the government announced that part of the proceeds from the resource tax will be contributed to a ‘resource state infrastructure fund’ and distributed to the states, particularly the resource-rich states, to finance resource-related infrastructure. This measure, combined with the resource exploration rebate, is supposed to account for ‘approximately one third’ of the proceeds of the resource tax. In the first full year, however, they’re expected to make up less than half that.
Timing: the resource tax isn’t due to begin for more than two years - July 2012 - and so all the other parts of the package are begun or phased in from that date.
The Henry tax review
The tax package was produced as the government’s response to the Henry review panel’s comprehensive review of the Australian tax and transfer system, federal and state. It’s the first comprehensive review since the Asprey report of 1975. Just as the Asprey report set the direction for tax reform over the following 25 years, so Ken Henry’s goal was to lay down a blueprint to guide further reform over coming decades, whether by this government or its successors. Henry set out proposals to:
• concentrate federal and state revenue-raising on four broad-based taxes: personal income, business income, rents on natural resources and land, and private consumption. Other taxes should be retained only where they serve social purposes or internalise negative externalities (eg gambling, tobacco and alcohol taxes, petrol taxes, pollution taxes). State taxes on insurance, conveyancing and other stamp duties and payroll tax should be replaced by a comprehensive 1 pc land tax and a ’broad-based cash flow tax’ (a simplified GST-type tax). (The objection to payroll tax is not that it’s a tax on labour - so is the GST - but that its high threshold means only larger businesses are taxed.)
• change the mix of taxation to reduce reliance on taxing mobile resources (eg business income) and increase reliance on taxing immobile resources (eg land and resources, and consumption). The company tax rate should be reduced from 30 pc to 25 pc. State royalty charges on minerals should be replaced by a resource rent tax levied at 40 pc.
• introduce a new two-step income tax scale with a tax-free threshold of $25,000 (but with the low-income tax offset and other offsets abolished), a 35 pc rate to $180,000 (but the 1.5 pc Medicare levy abolished) and (the present) 45 pc rate above that.
• regularise the widely disparate rates of tax on income from savings by allowing a 40 pc discount on income from interest, rent and capital gains, but also on deductions for interest expense of rental properties.
• improve the targeting of cash transfer payments.
• reform the taxation of superannuation by abolishing the 15 pc tax on contributions. People’s contributions should be taxed at their marginal rate, but they should receive a tax offset designed to ensure low income earners pay no net tax on contributions, middle income earners pay no more than 15 pc and only high income earners pay more than 15 pc. This would greatly improve the present inequitable distribution of the super tax concession. The tax on fund earnings should be halved to 7.5 pc. These two measures would lead eventually to greater super payouts, particularly for low and middle earners, making a rise in the compulsory contribution rate unnecessary.
• improve the taxing of roads by introducing congestion pricing that varies by time of day, using the proceeds to replace the tax element of motor vehicle registrations and possibly fuel taxes. Heavy vehicles should pay changes reflecting the damage they do to roads.
• reduce the complexity of the tax system, including by using an optional standard deduction for work-related expenses to simplify the completion of tax returns and save on tax agents’ fees.
The package as tax reform
The Rudd government’s response to the Henry tax review was surprisingly limited. Of the review’s 138 recommendations, the government accepted and acted upon just a couple, explicitly rejected 19 politically controversial proposals and failed to comment on the rest. In other words, it cherry-picked the report, selecting just a few things it thought would bring short-term electoral benefit.
The report contained many politically difficult recommendations but one that was particularly attractive: a proposal to introduce a whole new source of revenue by using a federal resource rent tax to replace the states’ mineral royalty charges. Here the government had some highly respected economists urging it to introduce a lucrative new tax on an unpopular, mainly foreign-owned industry and assuring it the tax would do nothing to discourage mining or hurt the economy.
It could use the new tax to pay for various politically attractive ‘reforms’, to be introduced after it was re-elected. The resource rent tax it announced was in line with Henry’s recommendations, except for a spin-doctor-inspired name change to the ‘resource super-profits tax’. The tax is being opposed by the Opposition and bitterly resisted by the big mining companies, which have won a fair bit of sympathy from wider business community. This resistance has caused many voters to wonder whether the tax would be bad for the economy, but almost all the criticisms are unjustified. Precisely so as to ensure the tax doesn’t do the bad things it is being accused of, it is hugely complex, meaning that many of its critics simply don’t understand how it would work.
When you look at the other supposed reforms, however, you find they bear little resemblance to the Henry report’s recommendations:
• It did propose a cut in the company tax rate, but to 25 pc not 28 pc.
• It did propose the instant write-off of assets, but for those costing less than $10,000 not $5000.
• On superannuation, the report proposed that the cost of increasing the concession on contributions by lower income earners be covered by reducing the concession to higher income earners. The government did the nice bit but not the nasty bit. The government did nothing about halving the tax on fund earnings as recommended. The report specifically avoided recommending an increase in the rate of compulsory contributions, but we got on anyway.
• The report recommended a thorough overhaul of the tax on savings, with the 50 pc discount on capital gains cut to 40 pc and the 40 pc discount extended to interest income and the interest expense deductions on rental property. The government introduced a 50 pc discount for interest income, but with a cap of $1000 in interest income. It made no changes to the capital gains discount or to negative gearing.
• The introduction of a standard deduction for work-related expenses was in line with the report’s proposals (though it may have been more generous that the report had in mind) and the report said nothing about introducing a new infrastructure fund.
The economic rationale for the resource super-profits tax
The present state government royalties - which aren’t so much taxes as charges for the use of mineral resources belonging to the community - are quite inefficient because they are based either on quantity (a price per tonne) or on a certain percentage of the market price. This means they take no account of the cost of mining the mineral, which varies from site to site and may increase as the exploitation of a particular site moves from the easily extracted to the hard-to-extract. Thus the present royalties can have the effect of making a prospective site uneconomic and discouraging the full exploitation of a site. This inflexibility limits the ability of state governments to raise the rate of the royalty when world commodity prices are high. (They may also be inhibited by perceived competition between the states or unduly close relations with the mining companies.)
The beauty of the super-profits tax (and the existing petroleum resource rent tax) is that, because they are based on taking a share of super-normal profits, they don’t discourage the exploitation of marginal sites, nor encourage the under-exploitation of existing sites. They are highly flexible, taking higher royalties when world commodity prices are high, but automatically reducing the take when world prices fall. There will be times when world prices fall to the point where some sites are paying no royalty-equivalent (the resource tax) and there will be some sites with high production costs that never have to pay royalties.
Super-normal profits are profits received in excess of those needed to keep the capital employed within the business rather than leaving in search of more profitable opportunities. So super-normal profit represents ‘economic rent’ - any amount you receive in excess of the amount needed to keep you doing what you’re doing, your opportunity cost. Accountants and economists calculate profit differently. Accountants take revenue, subtract operating costs and regard the remainder as profit. But economists also subtract normal profit - the minimum acceptable rate of return on the capital invested in the business - which they regard as an additional cost, the cost of capital. The appropriate rate of return must be ‘risk-adjusted’ ie the higher the risk of the business operating at a loss, the higher the rate of return above the risk-free rate of return, usually taken to be the long-term government bond rate.
(This is what’s so silly about the mistaken claim that the resource tax regards any profit in excess of the bond rate as super profit. The risk is taken into account not by adding a margin to the bond rate [as occurs with the petroleum resource rent tax] but directly, by having the government, in effect, bear 40 pc of the cost of the project, including losses.)
Most taxes on an economic activity have the effect of discouraging that activity. This is clear in the case of the existing royalty charges. But resource rent taxes (including the resource super-profits tax) have been carefully designed to have minimal effect on the taxed activity. Because the return on capital remains above its opportunity cost, activity should not be discouraged, meaning there should not be any adverse effect on employment or economic growth. Indeed, because of the more favourable treatment of marginal projects, there should be more employment and growth.
Economic theory says a resource rent tax should not add to the prices being charged by the taxed firms because it does nothing to add to their costs (as opposed to the effect on their after-tax profits) and because the firm is already charging as much as the market will bear. In practice, it may not be charging as much as it could. So a better argument is that our mining companies are price-takers on the international market, with Australian producers’ share of the world market not big enough to have much effect on the world price.
The fact that resource rent taxes have been explicitly designed not to do all the bad things the vested interests accuse them of doing explains the strong support for such taxes from economists. The resource rent tax is actually the proud invention of Australian economists, available to be copied by other countries.
The package as short-term macro management
The tax package is roughly revenue neutral over the next four financial years. It can be thought of as detachable - should the resource tax not be passed by the Senate, none of the measures it finances would go ahead, thus leaving the budget little affected.
This means it’s wrong to imagine the resource tax would play a significant part in returning the budget to surplus. The budget is projected to reach (negligible) surplus in 2012-13 for three reasons:
• the effect on the budget’s automatic stabilisers of the economy’s expected return to strong growth
• the always-planned completion of the government’s temporary stimulus measures
• the government’s adherence to its ‘deficit exit strategy’ of allowing the level of tax receipts to recover naturally as the economy improves (ie avoid further tax cuts) and holding the real growth in spending to 2 pc a year until a surplus of 1 pc of GDP has been achieved.
The fact that the government now expects the return to surplus to occur three years’ earlier than it expected in last year’s budget is explained by the much milder recession than it expected and the much stronger forecasts for the next four years. Various factors caused the recession to be so mild, including the V-shaped recovery in China and the rest of developing Asia, and the consequent bounce-back in coal and iron ore prices.
In view of the government’s commitment to limiting the real growth in its spending to 2 pc, it’s worth noting that virtually all the things on which it intends to ‘spend’ the proceeds from the resource tax are tax cuts and tax concessions. That is, the package has been structured so as to add little to the government’s difficultly in meeting its 2 pc target. The qualification to this is the plan to put about $700 million a year into the new state infrastructure fund. My guess is that contributions to the fund have been designed to be the ‘swing instrument’ - that is, to be reduced or even eliminated should collections from the resource tax fall short of projections.
The package as long-term macro management
Because the resource tax is designed to be heavily influenced by the ups and down in world commodity prices, receipts from it are likely to be highly variable over the years. By contrast, the cost to revenue of the tax cuts and concessions it finances is likely to be far less variable. For an accountant-type, as Peter Costello appeared to be, this would be a worry. The tax package will make the budget balance much more cyclical. For an economist, however, this is a virtue: by introducing the resource tax the government has added a new and powerful automatic stabiliser to its budgetary armoury.
Because Australia is such a major producer of mineral commodities, the cycle in world commodity prices is likely to align pretty closely with our business cycle. Whenever we’re in a resources boom, close to full capacity and with the Reserve Bank worried about inflation pressure, the resource tax will take more revenue from the boom sector and send it to the budget. Provided this extra revenue isn’t spent or used to repeatedly cut income tax (as it was in John Howard’s day) it will act as a drag on the economy, reducing inflation pressure and hence the need for higher interest rates. Whenever we’re in a resources bust, the economy has turned down and unemployment is rising, resource tax collections will collapse, the budget will go more quickly and more deeply into deficit and this will be the automatic stabilisers working to help prop up the private sector and put a floor under the downturn.
The tax package can be seen as an attempt to improve the economic managers’ ability to manage the economy during resources booms: to chop the top off them and make them less inflationary, but also to ensure we have more to show from them when they’ve passed. The contributions to the state infrastructure fund are a way of requiring the miners to contribute more towards their own additional infrastructure requirements.
More significantly, the linking of the resource tax with an increase in compulsory superannuation contributions should ensure at least some of the income from the boom is saved rather than spent. Empirical evidence suggests the introduction of compulsory super has done more to increase national saving than conventional analysis led us to expect. (The practical weakness in the argument is that the super increase is being phased in so slowly - the first tiny increase takes place in July 2013 and the last in July 2019 - the boom could be long past its peak by then.)
Ceteris paribus, an increase in national saving will cause our current account deficit and foreign liabilities to be lower than otherwise - always remembering that the resumed resources boom is expected to cause the CAD to be high for a protracted period. The small cut in company tax may make Australia more attractive as a destination for foreign investment, particularly equity investment. Combined with the higher national saving and potential for interest rates to be less high than otherwise (less weight on monetary policy), it’s possible to see this leading to a lower exchange rate than otherwise.
When it comes to matters economic, the cultural cringe is alive and well. Australians lack confidence in ourselves and our own inventiveness. We see our country's rightful place as a follower of international trends, never a leader of them. We seek the approval of foreigners and fear their disapprobation.
One of the favourite Australian laments is the story about some wonderful new invention that local bankers or businessmen lacked the either the wit or the courage to take up, thus forcing the inventor to take his idea abroad for development and losing for Australia all the profits that could have flowed.
We've heard such stories so many times most of us hold this view of Australia as an article of faith. A related belief - so deeply held it's impervious to contrary evidence - is that we suffer a terrible Brain Drain as our brightest young scientists and professionals move abroad in search of the opportunities we deny them.
These narratives may seem to contradict my case: we know full well how valuable our inventions and young people are, how happy the rest of the world is to take them off our hands. At another level, however, they reveal our cringe: trust us Aussies to keep stuffing up.
They also reveal our protectionist predilections: good things should be kept at home, which is the only way they can benefit us. To let them leave is to lose.
There was a time when Australia was happy to do things its own way for its own reasons. What the rest of the world thought we neither knew nor cared. But some of the things we pioneered were copied by others and when we learnt of it we were proud.
Australia (and our Tasman cousins) led the world in electoral reform. In 1856 we began introducing the secret ballot. When the rest of the world began copying us, it became known as the "Australian ballot".
The Kiwis pioneered votes for women in 1893, South Australia followed in 1894. Again, the rest of the world followed.
Our use of compulsory voting hasn't caught on elsewhere, but why should we care? We don't. But as the Brits consider abandoning their first-past-the-post voting system, some are saying they should switch to "the Australian system" of preferential voting.
But all those intellectual inventions were a long time ago. It's more recently that we seem to have acquired our self-doubt, our suspicion that if we're leading the world on something we're sticking our neck out and have probably got it wrong. Our desire to be a trend follower, never a trend setter.
You see that in a common attitude to the plan for an emissions trading scheme. Why should we be the first? (We wouldn't have been, but let it pass.) What about the big boys? What are they doing? Wouldn't it be safer to wait until everyone else has moved?
Admittedly, this is not a case where what the rest of the world does doesn't matter. Only concerted international action will succeed in lowering global emissions. Even so, a self-confident nation would have seen the advantages of being among the first to take the plunge. The sooner we make a start, the lower the ultimate cost of making the transition to a low-carbon world.
And since Australia has a lot to lose from climate change, why don't we try to break the stand-off, set the others a good example and press them to join us? Aren't the stakes high enough to justify taking a bit of a risk?
All these were Kevin Rudd's arguments until his failure of leadership. Now he has succumbed to the national timidity and joined the Poor Little Australia party, waiting for the world to determine our fate.
In their fight to avoid paying more tax, the big mining companies are seeking to play on our self-doubts. No other country has such a resource tax, they claim, and nowhere else are they required to pay so much. If Australia persists with this weird tax they'll cancel their projects and take their money elsewhere.
Oh dear, don't desert us. Please!
Know what their problem is? Australia, being one of the world's leading mining nations, is a world leader in designing taxes that increase the public's take without discouraging mining activity or otherwise damaging the economy.
The resource super-profits tax is a state-of-the-art tax, designed by our leading economists not to do all the bad things it's being accused of. It's a close relative of an earlier Australian invention, the resource rent tax, developed by Professor Ross Garnaut and others at the Australian National University.
The big international mining companies are fighting it partly because they fear that, once its success has been demonstrated, it will be copied by other countries. And they're fighting it by trying to press our cringe button: if no one else is doing it, it must be a dumb thing to do.
The miners are right to fear the tax will be adopted by other countries because that's just what's happened to that other great invention of Australian economists, the "income-contingent loan" (known to you as HECS, the higher education contribution scheme). This one was invented by Professor Bruce Chapman, also of the ANU.
We cringers think of Australia as a small country that carries no weight in the world. But the world's big companies see us as a potential setter of dangerous precedents. Whenever we decide to do something novel that could impinge on their profits, they quietly assist their local colleagues in trying to dissuade us.
The world's tobacco companies are still trying to prevent us preceding with our path-breaking move to plain cigarette packaging. When the Reserve Bank moved to end the banks' ban on shopkeepers charging a fee to people paying by credit card, the two international card companies were most agitated.
Turns out the world has more faith in Australian innovations than we do.
Kevin Rudd has his back to the wall. He's no fighter, but he has little option but to stand and fight for his bitterly resisted resource super profits tax. With luck the experience will help turn him into the more substantial figure we need to lead us.
All Rudd's instincts - and those of the Hollow Men on whose counsel he relies - must be to ditch or greatly water down a tax he now discovers has proved hugely unpopular with the miners and which an economically uncomprehending business community doesn't like the sound of.
For a man who's always searching for a soft cop - those "reforms" that are riding high in the opinion polls, such as health care and, formerly, action on climate change - this must have come as a great shock to him.
But Rudd has no choice but to stand and fight. Having instantly shredded his credibility with his cowardly decision to cut and run from his emissions trading scheme when its popularity slipped, he simply can't afford another blow to his reputation.
If that's not enough, there's this: almost all the nice things he's promising to do if he's re-elected - cut company tax, help small business, further subsidise superannuation and the rest - hang off the resource tax. No tax, no goodies.
Normally, a prime minister has room for tweaks to placate the vested interests, but this time Rudd has none. His credibility is too low.
And the precedent of weakness he set with all his cave-ins to miners and other rent-seekers over the emissions trading scheme means giving the miners something this time would be more likely to further incite their greed than calm them.
Rudd is a weak man fallen among thieves. He may be from Queensland, but his moral compass now comes courtesy of Sussex Street. I'm sure he remains convinced of his own uprightness, but clinging to office comes first.
Actually, for a bunch that puts political expediency above all, Rudd's cynical advisers have made a succession of bad calls. They imagined they could give in to the rent-seekers on emissions trading without being seen as an easy mark on every subsequent business issue.
They quailed at the thought of defending "a great big new tax" at a double-dissolution election, and deluded themselves that if they ditched the emissions scheme no one but a few greenies would care.
They commissioned the Henry tax review without thinking through the implications of having it lob just before an election. Then they imagined they could turn it into a get-out-of-jail-free card.
Introduce a big new tax on a group for which no one had much sympathy - the big, largely foreign-owned mining companies - then use it to pay for a raft of supposed reforms, carefully chosen for their vote-catching abilities, without adversely affecting the return to surplus.
And this lucrative tax came with the economic rationalists' Good Policy seal of approval, co-signed by Dr Ken Henry and Professor Ross Garnaut. Economic imprimaturs don't come from any higher authority.
One small problem: the resource tax is so pure - so carefully designed to ensure it doesn't do all the bad things it's being accused of - that it's impossible for anyone who's not a paid-up economist to understand.
Worse, its most prominent feature, the allowance rate set at the long-term bond rate, makes every ignorant Fin Review reader (and most of the business commentariat) imagine they can see the glaring flaw Henry and Garnaut missed. Yeah, sure.
We must assume that, unlike all the rest, the miners themselves have studied the complex design of the tax and disabused themselves of this beginner's error. But are they going to dispel or to exploit the business punters' illiteracy? One guess.
Did Rudd's whatever-it-takes political smarties see that one coming? I bet they didn't. Nor did they foresee the way the miners, aided by a hostile state government, would use the tax to heighten the West Australian electorate's resentful delusion that their state's propping up the rest of the economy Back East.
Did it occur to the political experts that all Tony Abbott had to do to solve the Liberals' acute lack of election funding was to oppose the tax then pass the hat round the miners? I doubt it.
Did it occur to the spin doctors that getting the business community and even the wider electorate to accept the wisdom and fairness of this tax would require an enormous effort by expert wordsmiths to formulate and feed ministers with simple ways of explaining the otherwise incomprehensible, rather than relying on their usual tricks of emotive slogans and manipulating the news cycle?
I doubt it. You can see that from the way some smarty decided to rename the Henry report's resource rent tax as the resource super profits tax. The half-baked notion was to heighten the great unwashed's resentment of foreign mining giants.
What it actually did was heighten the resentment of the miners and the sympathy of the wider business community by rubbing in the notion that this was an additional tax on company profits, levied at 40 per cent. That's a false perception, but it acted as red rag to a bull.
Had the perception managers understood the economics, they would have realised the measure was more a complex-calculated price for the use of natural resources owned by the Australian people than a tax, and renamed it something like the "reasonable royalty charge".
Rudd has been badly served by his spin doctors and advisers. They've led him astray and dropped him in it. If he's got any sense he'll switch to giving the electorate what it's shown it wants: a leader who is honest, straight-talking and principled.
Remember the two-speed economy? It's not back. No, with the return of the resources boom we're going back to the three-speed economy.
That's according to an enlightening speech this week from the secretary to the Treasury, Dr Ken Henry.
Assuming the continuing global financial crisis doesn't reassert itself to the point of knocking China and India off their present growth paths - a reasonable assumption - the big non-environmental issue facing our economy over the next few years or even decades is the profound implications of Australia's return to riding on the back of a coal train. Expect to hear a lot more about it.
As we saw during the resources boom that ran for five years before being (briefly, as we now know) interrupted by the global recession in 2008-09, when the global demand for commodities such as coal and iron ore runs way ahead of their supply, this has big effects on our economy.
The leap in the prices the world is prepared to pay for our exports of those commodities greatly increases the nation's real income. The spending of that income (including the part that ends up in the government's coffers because of higher company tax collections) gives a great boost to demand and employment.
As well, we get a huge increase in mining and related construction activity as the high prices they are receiving prompt the miners to greatly expand their production capacity.
At the same time, the improvement in our terms of trade - the prices we receive for our exports relative to the prices we pay for our imports - usually leads to a significant appreciation in our exchange rate.
And if all this happens at a time when the economy has little spare capacity and unemployment is low, the Reserve Bank soon starts to worry about rising wages and inflation pressure and begins trying to slow demand by jacking up interest rates.
That's where we were before the global financial crisis hit and it looks like where we will soon be returning.
If you look at how this affects the economy geographically, you see a two-speed economy. Queensland and Western Australia are in the fast lane, all the rest of the country is in the slow lane.
It's only when you divide the economy up by industry rather than by state that you see there are actually three lanes.
In the fast lane are mining and mining-related sectors (the mining services industry and even the heavy construction industry). These industries grow fast because the rise in the prices they're getting far outweighs the adverse effect on them of the higher exchange rate.
In the slow lane are the other trade-exposed sectors, such as agriculture, manufacturing, inbound tourism and inbound education. These export or import-competing industries suffer because their prices haven't increased but the higher exchange rate has reduced their price competitiveness, either by reducing the number of Aussie dollars they receive for exports or by reducing the Aussie-dollar cost of the imports they compete against.
In the middle lane are the rest of our industries, which Henry calls the "non-traded sectors". Most of the non-traded sector is filled by service industries, but it includes goods industries selling stuff that cannot be exported or imported. It accounts for about three-quarters of the economy.
These industries will grow at a rate somewhere between the other two lanes.
Just how fast they grow depends on the relative strengths of the "negative supply shock" - arising because workers and capital are being competed away by the expanding resources sector - and the "positive demand shock" - arising from the nation's better terms of trade and higher real income, part of which raises demand for the non-traded sector's products.
Because these conflicting shocks cause demand and supply in the non-traded sector to be out of balance - with demand stronger and supply weaker - the sector's prices will rise to restore the balance.
This means Australia's inflation rate is likely to rise above the average of our trading partners' inflation rates. And this will cause the rise in the nominal exchange rate (the one we see) to become also a rise in our real exchange rate (which happens when our inflation rate exceeds the average - even without a nominal appreciation).
Fine. But before we start a long debate about the wider implications of a resurgent resources boom the threshold question is: how long will it last? Is it temporary or lasting? No one knows, of course, but Henry says there are three considerations.
The first is the global supply response to the increased demand for resources. "Sustained periods of strong prices and strengthened long-run price expectations can be expected to generate even stronger mining exploration and investment responses over time," Henry says.
"They can also drive a reassessment of the size of global mineral reserves that are recoverable at a commercially viable rate. And technological improvements will continue to place downward pressure on extraction costs."
So some of the short-run increase in prices is likely to be temporary. (The budget forecasts are based on an assumption that terms of trade deteriorate over time by 20 per cent.)
Second, there seems to be a long-term decline in commodity prices. In the last half of the 20th century, non-fuel commodity prices fell on average by 1.6 per cent a year relative to consumer prices.
But Henry argues that particular commodities can buck the general trend over protracted periods. For instance, the real world price of copper roughly doubled between 1930 and 1970.
And you can argue that the prices of non-renewable resources will be forced upwards over time as reserves are depleted and the cost of extraction rises as producers are pushed towards more marginal deposits.
Third, the rapid industrialisation of countries such as China and India still has a long way to run. The likelihood is that they will catch up with the developed countries, just as Japan, Korea, Taiwan and Singapore did before them.
Research says an emerging economy's demand for metals grows strongly until its income per person reaches about $20,000 a year.
Putting these three considerations together, Henry concludes we have at least reasonable grounds for believing that strong world demand for Australian commodities, and favourable terms of trade, will be "sustained for some time".
In the cautious way econocrats speak, "sustained for some time" means quite a few years. That's why we need to have a long think about the implications.
The most thought-provoking comment I've seen on the budget came from Senator Christine Milne of the Greens. ''Every Australian knows,'' she said, ''that if you have two credit cards, it is very bad management to pay off your debt on one of them by racking it up on the other.'' The budget ''pulled down the national economic debt, but it continued the process of racking up our ecological debt''.
Sadly, it's true. The budget formally records Kevin Rudd's failure of leadership with his cowardly and illogical decision to shelve his emissions trading scheme.
It shows he took steps to avoid being accused of using the abandonment of the scheme to hasten the budget's return to surplus by using the net cash saving involved - $653 million - to increase spending on renewable energy.
The reversal did make it possible for the Government to meet its commitment to limit the real growth in its spending to 2 per cent a year.
And it did mean it was abandoning a ''great big new tax on everything'' in favour of a great big new tax on the mining companies, with the proceeds to be used to buy votes with a range of tax cuts and concessions - surely a net political gain.
Even so, if the government wants to insist it was motivated more by lack of political courage than by budgetary expediency, I accept its protestation.
No, that's not the point. It's that the budget continues our practice of worrying intensely about what we're doing to the economy while ignoring what we're doing to the environment. We just took a decision to take our chances on global warming - to do nothing to prepare for global action on climate change and nothing to set an example others might follow - but nowhere does that show up as a cost or liability.
It's not in the budget, nor in gross domestic product. It's invisible. We carefully measure and hugely publicise any increase in government debt or setback in economic growth, but what our actions and inactions are doing to the environment is largely out of sight.
When we run down our non-renewable resources (as we're hoping to do at a much faster rate with the return of the resources boom), nowhere does this show up as a cost or reduction of our assets. When we continue to deplete renewable resources at a rate much faster than they can renew themselves, nowhere does this show up as any kind of negative.
When we continue pumping our waste back into the environment - including greenhouse gases, but also other air and water pollution, garbage and human waste - at a faster rate than it can absorb, nowhere is this recorded as a cost.
GDP, our great de facto measure of progress, counts the short-term benefits from all this exploitation, but ignores its long-term costs. So Milne is right: we have been paying off our economic credit card by racking up debt on our environmental credit card.
But as the still-unfolding global financial crisis reminds us, you can get away with racking up debt only for so long. And with the environment the day of reckoning has already started to dawn. Lift your head from the economic statistics and you see rising average temperatures, the clearing of native forests, the destruction of habitat, the decline in fish stocks, the damage we've done to the Murray-Darling and other river systems and the degrading of our soil.
So far we've managed to keep the economy separate from the environment, but we won't get away with that much longer. Why not? Because, in the words of a former US senator, ''the economy is a wholly owned subsidiary of the environment''.
The economy exists within the natural environment and is dependent on it. Logically, you could have the natural world without an economy - that is, without human activity - but you couldn't have an economy without a natural world.
We can go for a period running our economy at the expense of the environment - plundering its natural resources on one hand, pumping out our waste on the other - but eventually we start to get feedback. The despoiled and depleted ecosystem begins to malfunction, with serious consequences for the continued functioning of our economy.
We get a lot more extreme (and thus expensive) weather events, a rising sea level forces us to move back from the coast, we start running out of native forests and some mineral resources and fossil fuels (making energy and fertiliser a lot dearer), we see the destruction of international tourist attractions such as the Great Barrier Reef,
we have to move agriculture north to where the rain is, but the elimination of fish stocks and degradation of soil makes food production a lot harder and more expensive the world over.
How did we get into the mindset that allowed us to take the environment for granted? Well, mainly it's because economic activity is simply more visible than the environment. And because, until relatively recently, we could plunder the natural world with impunity.
But also because we're wedded to a way of thinking about (and measuring) the economy that, because it has changed little in the past 150 years, simply ignores the environment. Because at the time global economic activity was so small relative to the huge natural world, it made sense for the early economists to treat the environment as a ''free good'' - something so plentiful it comes without cost.
But with the human population having more than trebled since 1927 and the global standard of living also having risen considerably, it's no longer sensible to treat the environment as an ''externality''.
We need a new economic model - and a new way of measuring progress - that recognises the centrality of the environment to our wellbeing and keeps recording and reminding us when we charge things up on our environmental credit card, as Rudd has just done.
The annual debate about the budget gets ever more unreal. This year it reached the height of absurdity. Budgets used to be about what the government plans to do in the coming financial year. Now they're about what supposedly will happen any time over the next four years.
How unreal can you get? Who on earth knows what will happen over the next four years? No one. Certainly not Treasury (nor any of the smarties who think they know better than it). This time last year Treasury's best guess was that unemployment would peak at 8.5 per cent next year; now we know it peaked at 5.8 per cent in the middle of last year.
This time last year we were told revenue collections over five years would be down $210 billion on what the "forward estimates" had told us the year before. Now we're told they'll be down $110 billion - but why would you set much store by that guess? We know from repeated experience that Treasury is quite bad at telling us in early May what the budget balance will be at the end of the following month. And yet we take seriously what it says the balance will be in three or four years' time.
This year there's been huge emphasis - encouraged by the government's rhetoric and amplified by the media (including yours truly) - on one figure: the projected budget balance in three years' time, a surplus of $1 billion. Hallelujah! Home and hosed. All over bar the shouting.
How absurd can you get? Treasury isn't even prepared to dignify this figure with the status of a "forecast"? It's the product of a completely mechanical, punch-in-predetermined-numbers "projection". Here's another absurdity: the public debate about the budget treats all its figures as if they were accomplished facts. No ifs or buts or maybes. And do the purse-string ministers - who know better than anyone how unreliable these figures are - make it their responsibility to warn us not to take them too literally? Not a bit of it.
Here's Lindsay Tanner: "The result is that we are back in surplus three years ahead of schedule in three years' time and the level of debt Australia has will be half of what was initially projected" (my emphasis).
Last year's projection was rubbish, but this year's is fact. Of all the (inescapably) rubbery figures in the budget, the one we've fixated on is the rubberiest: the $1 billion cash surplus in 2012-13. The one thing you can bet on is that the budget balance that year won't be a surplus of $1 billion.
One billion! One billion! Do you realise how infinitely small that figure is in what's projected to be a $378-billion budget and a $1.6-trillion economy?
What if it turns out to be an equally infinitesimal $2 billion overestimate? Oh my lord, still in deficit! By any sensible metric, any outcome within $5 billion either side of zero represents a balanced budget. Why allow commonsense to spoil a good story?
This relatively recent shift from focusing on the budget year to taking a blurry look at the next four years has made it easier for governments to manipulate our perceptions of the budget. And boy, weren't the pollies working hard at it this year.
The budget papers boast that all the new budget measures since November "have been delivered within the fiscal strategy and are fully offset over the forward estimates by a reprioritisation of other policies".
Reprioritisation? That's the latest econocrats' weasel word. What does it mean, exactly? We're not told. I think we're meant to guess it's a euphemism for spending cuts (think canning the home insulation scheme and breaking the election promise to build 260 childcare centres).
I suspect it also covers changing the timing of spending, pushing it off into the future beyond the four-year forward estimates. Consider defence spending. About 10 days before last year's budget Kevin Rudd made a grand announcement that the previous government's commitment to increasing real defence spending by 3 per cent a year would be continued.
But 10 days later the budget pushed a lot of that spending (mainly the purchase of major equipment) off into the never-never. This year's budget papers say real defence spending is expected to fall by 6.5 per cent in 2011-12 and by a further 3.8 per cent in 2012-13 (the year we supposedly return to surplus).
Then, however, it grows by 5.3 per cent the year after (and, if we only knew, no doubt skyrockets in the years beyond the forward estimates). Rudd's grand promise just gets rolled further and further into the future.
Though it's true Rudd's new spending programs are planned to be fully offset by "reprioritisation" over the forward estimates, it won't become true until the last year of the forward estimates, 2013-14, when "saves" are intended to exceed "spends" by $5.9 billion. Until then, spends exceed saves - and worsen the budget balance - by $1.9 billion this financial year, $2.4 billion in the new financial year and $2 billion in 2012-13. See what I mean about exploiting the four-year fuzzy focus?
Then we have the discovery by Joe Hockey's people that some helpful fiscal fairies improved the budget's profile of ever-diminishing deficits by bringing $1.8 billion in spending forward to this financial year, thus making the base-year higher and the subsequent improvement greater.
The other trick is that so many of the vote-buying goodies - the cut in company tax, the small-business instant write-off, the superannuation concessions, the new standard deduction and the bank interest concession - don't take effect for two or three years. This budget's "fiscal conservatism" rests heavily on the promise of pie in the sky sometime before you die.
The most common criticism of this week's budget is that the projected return to surplus in three years is no thanks to anything the Rudd government has done, but simply because of the returning resources boom.
There's much truth to this observation, but it also reveals an ignorance of the way budgets work and a willingness by some to make logically inconsistent criticisms of the government.
These people would have you believe the budget's descent from surplus to deficit was solely the result of the government's big spending, whereas the budget's return to surplus will be solely the result of forces beyond its control. That's wrong.
It is true that the $41 billion improvement in the projected budget balances for the four years to 2012-13 since the midyear review last November is more than fully explained by "parameter variations" (expected improvements in the economy).
But this should surprise only those who don't know much about budgets. It's always the upturn in the economy that brings the budget back into surplus. Why? Because it's always the downturn in the economy that does most to turn the surplus into a deficit.
In other words, the ups and downs in the budget balance are the product of two factors: what the economy does to the budget as it moves through the business cycle, and what the government does to the budget by its policy decisions.
The simple souls who fell for the opposition's claims that it was solely the government's reckless spending that had put the budget into deficit and was racking up debt that would be left to our grandchildren, were taken in because they assumed the budget balance could be affected only by government decisions.
Not true. The bigger factor affecting the shape of the budget is the economy. When it turns down, causing tax collections to fall and spending on dole payments to increase, it turns surpluses into deficits; when it turns back up, causing tax collections to rebound and spending on dole payments to fall, it turns deficits into surpluses.
This time last year, the government estimated the recession would reduce its tax collections by $210 billion over the five years to 2012-13. Now, with the mild recession behind us and the economy recovering, it has reduced that expected loss to $110 billion.
And, yes, that's the main reason the budget is now expected to return to surplus three years earlier than was expected a year ago.
Even so, that lost $110 billion was sufficient to wipe out five years of expected surpluses and push the budget into deficit. Then the government came along and initiated about $97 billion in stimulus spending. Together, those two factors explain the expected cumulative deficit of $137 billion over the five years to 2012-13.
It's because the economy does what the economy does that economists studying budgets focus their attention rather on what the government does. Did its decisions bolster the economy and help to minimise the downturn? Then, when the cycle has turned around, did it curtail its stimulus so as to get the budget back in surplus ASAP and start paying down the debt racked up during the recession?
The answer to the first question is, yes, the government's alleged reckless spending on fiscal stimulus did play a significant role (along with other factors, including the Reserve Bank's mammoth cut in interest rates) in keeping the recession so mild that the uninitiated even imagine we didn't have one.
Treasury calculates that the fiscal stimulus added about 2 percentage points to the growth in gross domestic product in 2009. Since the actual growth was 1.4 per cent, this says that without that stimulus the economy would have contracted by about 0.7 per cent.
The next question is: having used its discretionary spending to minimise the downturn, is the government now turning off that spending, and limiting any new spending, so as to allow the recovery in the economy to get the budget back in the black as soon as possible?
Surprisingly, the answer again is yes. That's why most economists gave the budget a tick this week. Though Kevin Rudd's first instinct is to spend, spend, spend, the budget revealed that the purse-string ministers, Wayne Swan and Lindsay Tanner, had managed to pull him into line.
The government had set itself a "fiscal framework" to ensure its actions were consistent with its "medium-term fiscal strategy" to "achieve budget surpluses, on average, over the medium term" and, despite the earlier scepticism of many, so far it's stuck to it.
The first element of the framework was the requirement that its explicit stimulus measures be temporary - that is, one-off. Because that spending was temporary, and most of it is past, the stimulus is now being withdrawn. That is, it's now exerting a contractionary influence on the economy.
According to Treasury's calculations, the withdrawal of the stimulus will subtract about 1 percentage point from gross domestic product growth this calendar year, and a further 0.75 percentage points in 2011. (I make that a subtraction of about 0.88 percentage points for the coming financial year, 2010-11.)
But the government makes many more budgetary decisions than just those officially labelled as "stimulus" and all decisions have an effect on the economy regardless of their label. To cover this, last year the government set itself a "deficit exit strategy".
It was that once the economy was returning to at least the trend rate of growth (with trend apparently being 3 per cent a year) it would, first, allow the level of tax receipts to recover naturally (that is, avoid further tax cuts) and, second, hold real growth in spending to no more than 2 per cent a year - all of this until the budget returns to surplus.
Without quite saying so, the government imposed on itself a third objective that all new spending measures be fully offset by savings measures over the four years of the forward estimates. And on Tuesday night, Swan announced an extension of the deficit exit strategy: "Once the budget returns to surplus, the government will maintain expenditure restraint by retaining a 2 per cent annual cap on real spending growth, on average, until the budget surplus is a least 1 per cent of GDP".
Bottom line: by hook or by crook (see my column on Monday), the government delivered on all these commitments. That's why, while all the political types were crying "it's just the resources boom," economists were giving the budget an unexpected tick.
The Prime Minister goes flat out all year, every year promising to spend money. Then the budget reckoning comes around.
Will wonders never cease? Economic rectitude with only a modicum of pain. With one leap Labor gets the budget back on track.
It should be back in surplus in 2012-13, three years earlier than expected, and all for just a bit of grief for people we have little sympathy for: the drug companies, tax accountants and welfare cheats.
And despite all his warnings about a no-frills budget, Wayne Swan did find room for a few sweeties: the halving of tax on bank interest and a new standard tax deduction of $500, rising to $1000.
Wow. Kevin Rudd, the great moral budgeter of our time. Or so he wants us to think.
Actually, it's an illusion. The reason last night's budget achieved such a good bottom line with so little fuss is that Rudd has spent the past three weeks announcing its major components.
To get the premiers to agree to his hospital changes he promised extra spending of $5.1 billion over five years (which last night swelled by another $2.2 billion).
That alone was enough to blow his budget off course, so to offset it he's been busy breaking promises and cutting spending. Kill off the promise to build 260 new childcare centres; scrap the home insulation scheme.
It's now clear that, as well as it having become more politically difficult, Rudd abandoned his emissions trading scheme to help solve his budgetary problems.
It helped in two ways: first, although it involved giving up revenue from the sale of emission permits, at the same time it cut government spending by more than $18 billion, thereby doing much to help achieve Swan's target of limiting the real growth in spending to 2 per cent a year.
Third, it dispensed with a fight with the mining companies to make room for a much more lucrative fight over the resources super profits tax. It replaced "a great big new tax on everything" with a great big new tax just on the big mining companies.
Last night's budget may not have been the sort of spendathon we got used to under John Howard, but that's because most of the expensive, vote-buying promises for Labor's next term were announced last week in its response to the Henry tax review: a cut in the rate of company tax, tax concessions for small business, new concessions for superannuation and a new infrastructure fund.
The new tax on miners would pay for all that and leave $3.5 billion over. Last night we learnt the tax was also paying for the lower tax on bank interest and the new standard tax deduction to make filling out tax returns much easier.
Then there was the 25 per cent rise in tobacco excise, set to raise an extra $5 billion over four years and thereby cover much of the increased healthcare spending. Last night's tightening up of the pharmaceutical benefits scheme (saving $2.5 billion over five years) will cover most of the rest.
With this, its third budget, the Rudd government's modus operandi has become clear. Rudd's first response to any problem is to reach for the cheque book. Fortunately for us, that happened to be just the right response to the global recession.
Rudd goes flat out all year, every year promising to spend money. At the same time, however, he's hugely sensitive to the opposition's charge that he's a bad economic manager who's leading us into deficits and debt.
So every year at budget time there's a reckoning, where the purse-string ministers force him to break promises and push off spending until the budget is back on track.
Rudd's decision to abandon action on climate change has prompted many to wonder what he really believes in. Now we know: the last value he clings to is fiscal conservatism. But it's a yearly struggle.
What happens when you ask perhaps the foremost tax expert in the country to conduct a "root and branch" review of the tax system? He recommends things no prominent businessman or retired judge would dream of proposing.
Few if any taxes are popular, but in all the submissions to the Henry review there was little agreement on which were the really bad ones - or on why they were so bad.
A lot of the arguments we have about particular taxes - whether they're achieving their objectives, whether they're doing more harm than good - are based mainly on the vested interests, ideology or some economic theory, freefall rather than objective evidence.
Has it ever occurred to you that the decisions governments make about what taxes to levy and the rates at which to levy them ought to be a lot more scientific? Based more on hard evidence than judgment?
Though the primary purpose of taxes is to raise revenue, most have stated policy objectives behind them. If nothing more specific, they're supposedly designed to minimise the tax system's distortion of the choices we make, to spread the burden of taxation fairly, to treat people in similar circumstances similarly, and to do all this in ways that leave people certain of their rights and responsibilities and don't generate high costs to comply.
Then we have the growing tendency to use taxes to correct the spillovers that occur when people make decisions but don't take into account their impact on others.
Sometimes the tax is intended more to change behaviour than raise revenue; sometimes the revenue raised compensates the losers from the spillover. Emissions trading schemes and carbon taxes are the latest examples of this, as is the push for congestion taxes.
But let's consider taxes on tobacco and alcohol. Ideally, tax on alcohol is set at the relevant "marginal social cost" - the level that transfers to drinkers the costs their actions impose on the community, as well as compensating the community for those costs.
How do we know the right level for the tax? We don't - not without collecting a lot more empirical evidence than we have now. More generally, we need to monitor the performance of the tax system better.
Henry says that "where possible, the performance of specific taxes and transfers should be measured objectively to identify whether they are meeting their policy objectives.
"An objective evidence base can reinforce public and government support for successful economic reforms and helps to determine when existing policy settings are no longer appropriate."
The paucity of information on specific taxes or cash transfers means data designed for other purposes are often used for analytical purposes, but this can be unsatisfactory.
Unbiased and systematically collected data on the tax system, based on widely accepted methodology and appropriate for tax policy purposes, are rare and often not publicly available.
Because such information is a public good - that is, the producers of it can't stop it being used by people who haven't paid for it - and even though society would benefit through improved tax policy based on it, the incentive for individuals or businesses to produce it is weak.
In any case, the capacity of non-government players to generate such information is limited because much of the data needed for the analysis is held by government.
All this says it's primarily governments' responsibility to generate - and make public - the needed information.
Henry adds that we would benefit from a system-wide study of taxpayers' compliance costs to monitor, on a continuous basis, the costs of complexity.
"Well-designed system-wide surveys are expensive," Henry says, "but they would provide valuable information on where simplification would yield the greatest returns".
Another area where we'd benefit from more information is on the extent of non-compliance with tax laws. The Tax Office doesn't derive estimates of non-compliance for key income and deduction items, nor publish these estimates.
Where people do examine the performance of taxes they tend to consider taxes separately. But this makes it difficult to get a sense of the system's combined performance and effects, and to determine whether it's making a coherent contribution to our national objectives.
So Henry recommends that federal and state governments systematically collect data on aspects of existing taxes and cash transfers - including compliance costs - according to consistent and transparent classifications and concepts, and make this information freely available for analysis and research.
He further recommends that every five years the feds publish a "tax and transfer analysis statement" on the overall performance and impact of the system, including estimates of efficiency costs and distributional impacts.
Academics, tax practitioners and the public should be encouraged to contribute to - and contest - the analysis in the statement. All data used and a full description of methodologies should be available to the public and subject to peer review. The government should also support one or more institutions to undertake independent policy research relevant to the tax and transfer system.
Only a man as possessed by the need for good tax design as Henry is would dare recommend such an egg-headed and expensive program just to make tax policy more "evidence-based", as the medicos like to say. But that doesn't mean he's wrong.
Just one of the major elements of the Henry tax review that Kevin Rudd brushed aside in his rush for a quick political fix was reform of the "transfer system". Huh?
In the jargon of economics, a transfer is a cash payment from the government to an individual, which isn't made in return for the receipt of goods and services.
So transfers include pensions, the dole and family benefits. You may think social security payments have nothing to do with taxation, but economists see the two as closely related. Taxes are cash going from us to the government; transfers are cash going from the government to us. For every dollar the federal government gets in, more than 25 goes out in transfers.
Indeed, the review's terms of reference required it to consider improvements to the "tax and transfer payments system" - note the implication: two components of a single system. Dr Ken Henry and his panel note that our transfer system is different from those in most developed countries. Its primary purpose is to provide a minimum adequate standard of living - meaning its goal is to alleviate poverty rather than help people maintain the incomes they enjoyed when they were working.
This emphasis just on avoiding poverty is the reason our system provides people with a flat rate of benefit (rather than a proportion of their former income) that's subject to a means test to ensure assistance goes only to the needy. This makes our transfer system the cheapest among the rich countries (which does much to explain why our level of taxation is lower than most of theirs). But it also means our system is the most "progressive" - it benefits the poor disproportionately to the rich.
A lot of people imagine progressivity comes from the choice of taxes you levy - lots of income tax and not much indirect tax. But you can also make the total system more progressive by biasing government spending in favour of low-income earners - which is just what we do.
Henry makes the further point that (contrary to the nonsense we keep hearing from the libertarian think tanks) means testing greatly reduces the degree of "churning" - taking money from people, then giving it back to them. Our system tends to take from the well-off and give it to the less well-off (which is what the well-off libertarians hate about it).
Now, it's clear from all the references to the "tax and transfer system" that one of the major goals of the review was to fully integrate the two systems - make them fit together better. That the two systems don't fit well can be seen from our frequent wrestling with the problem of high "effective marginal tax rates". Say a mother working full-time is considering moving to a tougher, higher-paying job. On each extra dollar she earns she would lose 31.5 in income tax. But she may also lose 30 in family benefit. If so, her marginal tax rate is, effectively, 61.5 in the dollar - well above the top tax rate of 46.5 and quite a disincentive.
It's clear the hope in getting the Henry review to look at the tax and transfer system was for it to find a comprehensive fix to the effective marginal tax problem.
But here's the scoop: it couldn't do it. After much effort it decided the two systems just couldn't be integrated. The problem is created by our love of means-testing, but is compounded because income tax is levied on the individual, whereas eligibility for transfer payments is based on the joint income of couples.
Its best suggestion was that the separate means tests for part A and part B of the family benefit be combined, with a single "withdrawal rate" of only 15 to 20 for each extra dollar of income earned.
The review turned to the range of transfer payments, saying their adequacy, structure and incentive effects could be improved. It says income-support payments should be divided into three categories reflecting society's expectations about the individual's ability to work.
Particularly with an ageing population, we want to encourage as many people to work as possible. The benefits of work are social as well as economic. It doesn't just provide you with an income, it makes you feel good to be part of the action. The first category is "pensions" - for the aged and the seriously disabled - where there's no expectation of work. Next is the "participation" category for those who are expected to work now or in the near future. This would include the unemployed and sole parents. The last category is "students", for young people undertaking full-time study.
The review notes that successive governments have allowed big gaps to emerge between the levels of benefits in the three categories with, for instance, the single-adult dole falling $108 a week below the single pension of $336 a week. "These differences produce very different outcomes for people with similar capacity to work," the review says. "They can create disincentives to work" or incentives to move on to payments (such as the disability support pension) that don't require you to look for a job.
It says these gaps should be reduced, and then each category's payment should be indexed on the same basis to prevent them widening again. But the gaps shouldn't be eliminated, with people in the participation category getting less than those on pensions, and students getting less again.
Why the differences? The dole should be lower than the pension to increase the incentive to find work and because it's assumed periods on the dole will be short. Students should get less because they can save by living at home or in groups and because they can work part-time.
Sorry, but this doesn't make sense to me. At present the single dole is only about 45 per cent of the minimum wage. People of working age face more costs than the elderly, not fewer. How much stick do the unemployed need to make them work? Hardly that much.
Maintaining a gap between the pension and the dole will continue to present a disincentive for sole parents to risk looking for work, lest all they find is a lower rate of benefit. But if you don't like what the review has proposed, don't worry.
It will be a long time before the government puts reforming the transfer system on its to-do list. It's happy to live with all the present deficiencies.
