The levy is right

According to the SMH this morning:

The Prime Minister, Julia Gillard, has all but confirmed that a one-off levy to help cover the cost of flood damage is on the cards but the bulk of funds will be raised by budget cuts.

Speaking before the inaugural meeting yesterday with the 13-member taskforce of business and industry leaders assembled to help co-ordinate and contribute to flood reparations, Ms Gillard said ”extraordinary circumstances” required ”very difficult decisions”.

”The federal government is going to step up and do everything we need to do to rebuild Queensland,” she said.

She said the contribution by business, both cash and in-kind and estimated to be worth about $500 million, ”is certainly not a substitute” for the eventual government contribution.

It is understood Treasury is working on budget cuts and the design of a levy before an announcement as early as next week. The Treasurer, Wayne Swan, will provide on Friday an estimate of the damage bill for roads, bridges and railway lines facing the federal government.

This blogger does not believe in fiscal surpluses for their own sake. There are times when you need to blow the Budget to keep the economy going.

However, that is not the case right now and there are some very good reasons why not imposing a levy is a bad idea.

The first is that by doing so, the extra stimulus entering an economy close to capacity constraints can cause inflation. That, in turn, will drive up interest rates, which flows through to a higher dollar, which puts further pressure on our non-resource tradable sectors of education, tourism and manufacturing.

In short, to not sterilise the stimulus is to ask the tradable goods sector to pay for the adjustment. That is, more Dutch Disease.

Yes, other sectors, like retail, may take some of the burden instead but that’s a better option in the national interest. We have an overspending/undersaving problem. Ultimately higher rates will hit them as well anyway.

Second, the need to return the Budget to surplus is not only an economic one. It is a risk mitigation issue too.

So long as the Great Australian Housing Bubble continues, and the banks that fund it rely on over $500 billion of offshore funding, the surplus is our fallback guarantee  on those debts. Returning it to surplus is a powerful symbol for global markets (and yes, as this blogger has argued before, symbols matter to markets) that Australia will and can stand behind those debts.

Please don’t misread this blogger, it offers no support for this system. It is a joke. But it would rather aim to correct it over time than through a calamity.

Third, there’s a moral dimension to the levy. This blogger has no problem chipping in for disaster relief across the big, brown land. Sooner or later our harsh mother may turn on any one of us.

The only point this blogger will add is that the levy should also apply to all corporations, who are set to benefit through the improved infrastructure, especially miners.

David Llewellyn-Smith

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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  1. Your last point regarding corporates is well made. The miners should pay through the reintroduction of a mining tax. We, the people need to start reinvesting some of the non renewable wealth being shipped out of our country.

  2. I think this depends on the time scale involved.
    In my opinion what we are experiencing now is a temporary relief from a very large and long debt recession, delayed by various stimulus designed to counter the GFC.
    So in the short term we want to avoid inflation as our bubble is currently re-inflating.
    But in the longer term it’s going to go again and we’re in for a lot more debt deflation.
    I think that whether or not a levy is better than deficit spending depends on when that turn-around happens.

    Although either way a tax is much preferable to spending cuts. For one thing the tax changes can be much more easily altered or reversed than spending changes, and with lower cost. Starting and stopping government projects is much harder and more expensive than fiddling with levies. And the levy can apply over a much shorter term where spending cuts have much slower, longer term effects.

  3. If the purpose of taxation is to destroy money so that the supply of money and hence inflation is restricted, then surely a levy is not required because the floods destroyed the money already.
    The spending in Queensland will not much of a inflationary effect in the rest of the country so tax the rest of the country?

  4. Sorry, brain on holiday!
    Last line should read:-
    The spending in Queensland will not have much of a inflationary effect in the rest of the country so why tax the rest of the country?

  5. David,

    I think you have fallen into the mindset of the inflation obsessed banking economists. They have collectively been telling us inflation is coming for years, yet it never arrives. I see that they were wrong yet again with the latest PPI.

    The reason they are continually wrong is that their definition of “full capacity” is incorrect and guided by their own vested interests. The truth is that the economy is nowhere near at full capacity as there is significant underemployment, and unemployment in certain age groups.
    In fact if you took a look for yourself at the current unemployment figures from the ABS you would see that the total hours worked actually declined in the latest data.

    In regards to a stimulus package being inflationary, once again I think you are falling into the bankers “broken window” mindset. A stimulus package of this kind would be to replace capacity that has been lost, not to add additional capacity.

    I loved your old blog and I really love this new one. But in this case I think you need to do a little research for yourself on what “full capacity” is and not simply rely on vested interest banking economist to provide you with this information. Once you have done that, you may want to re-assess whether a new tax is the best thing for the economy at this time.

    Thank you
    Jim Walters

  6. There may be some truth in your critique, Jim.

    Though I would dispute the notion that we haven’t had much inflation in the last decade.

    I still reckon the levy is the go, though. I don’t think we need more activity with the big income boost headed our way from rocketing iron ore and coal prices.

    I’m more worried about keeping the economy in check at the moment, until the bust…

  7. I agree with David here, we have had a great deal of inflation in Australia over the past decade. The CPI basket is flawed through survival bias, and is only consumer items. If there was a basket on non-tradables and asset prices, thus housing prices, calling out a tradesman to repair something, and compare the margina; increase between the farmgate and the supermarket shelf in the value chain, and you’ll see prices have gone up immensely. We’ve been sheltered due to the price of tradables, and we’ve basically sacrificed our domestic producers to accept the low prices for tradables.

  8. How about 1 of U economic bloggers do a big picture overview of the Aussie economy? All the markers are there. Dropping GDP, dropping PPI, dropping CPI, (Take food out of current figures of 2.2% YoY, U end up with a CPI of 0.5%), (I know 0.5% isnt real world), dropping employment. (2,700 jobs last release, doesn’t even keep up with immigration). All the pins are lining up but all reports done are on peripheral items but nothing on the dynamics of whats happening at the moment. Hope that makes sense.

  9. Aaron, David.

    Yes there has been a great deal of inflation in Australia over the past decade, but if you have a look at the data for credit you can see why.

    This has not been driven by “real” economic activity, it has been driven by ever increasing credit and housing speculation (as David said).

    Once that credit demand declines ( I see that your Dr Delusion has already mentioned this) then so will that “unreal” inflation.

    I think you need to take this into account. It is another reason why inflation isn’t appearing. Falling demand for new credit is offsetting the terms of trade.

    Thanks again for this excellent SUPER blog.

    Jim Walters

  10. “…puts further pressure on our non-resource tradable sectors of education, tourism and manufacturing.”

    Just a heads up that there are other exporters outside education, tourism and manufacturing that are suffering from the Dutch Disease. Cochlear and CSL come to mind. Not to mention the thousands of small businesses trying to scratch a living together exporting services to the outside world.

  11. Cancel the NBN, which is stupid and put the money there into the flood.

    Or dont connect the NBN to my house, and put the $4000 it costs per household to the flood.

    why on earth do you think I should pay more taxes witht he government wasting the money they are taking off me already?

  12. Brian,

    I support the NBN. It’s the one government policy that holds out hope of boosting productivity for many years to come. And contrary to various opinions, there is no hope of the private sector ever delivering it.

    I agree that cuts could be found elsewhere.