The nation’s pundits are not happy with the MYEFO. And who could blame them? Implausible assumptions, failed and ad hoc new taxes, and for what? A Budget surplus that is short term, a risk to growth and perpetuates a dying economic growth model.
First to put the boot in is Warwick McKbbin who uses the recent IMF confession that fiscal multipliers are not what we thought they were to suggest the Government is slowing the economy:
In the 1980s the fiscal multipliers from global economic models were estimated to be between 0.4 and 3.5. During the next three decades the fiscal multiplier has fallen to be between 0.2 and 1.5 depending on the model.
The reason for the wide range of estimates comes down to the assumptions about the way consumers, corporations and other government policies respond.
For example, it matters what is assumed about monetary policy when fiscal policy changes. We know from simple theoretical models that a fiscal contraction in an economy with open capital markets and a floating exchange rate will tend to put downward pressure on interest rates as the central bank responds to the output slowdown, leading to a capital outflow which depreciates the exchange rate.
Lower interest rates and a weaker currency will increase investment and increase net exports, which will reduce the GDP loss from lower government spending. Thus there will be some “crowding in” of private expenditure, which will tend to cause a lower fiscal multiplier.
Exactly right. But McKibbin goes on to make the same mistake that the IMF did. He then turns to the ‘confidence fairy’:
A key issue is the credibility of the fiscal cuts. The more credible the future debt reduction, the more confidence will be generated in the private sector. In forcing substantial budget cuts on countries with a fixed exchange rate, the economic costs are increased. This undermines the credibility of the future cuts, which further increases the economic costs of fiscal cuts. This is what the IMF has been finding.
This is another version of the old Ricardian equivalence theory which argues that individuals:
…internalize the government’s budget constraint: as a result, the timing of any tax change does not affect their level of spending. Consequently, Ricardian equivalence suggests that it does not matter whether a government finances its spending with debt or a tax increase, because the effect on the total level of demand in the economy is the same.
Perhaps there is something in the idea during “normal times”. But when you find yourself in a scenario of high private sector indebtedness, in households especially, then government fiscal constraint may be internalised in entirely the opposite direction as consumers also start saving. Lower interest rates only accelerate deleveraging and the only “crowding in” that happens is in the cash mattress. That is the primary lesson of peripheral Europe.
Next in the conga line of criticism is the failure of the MRRT. From The Australian:
WAYNE Swan’s $1.1 billion budget surplus projection has received an immediate body blow, with the government’s new mining tax raising zero revenue in its first three months.
The Mid-Year Economic and Fiscal Outlook, which did not include the mining tax result, warned “weak external conditions are expected to affect mainly company profits, largely in the resource sector, resulting in substantial downgrades to company tax receipts”.
…Mining industry sources are suggesting company tax from the resources sector will be cut by much more than the government’s estimated $2.3bn drop from the budget to the MYEFO report.
Originally the MRRT was designed to collect $10.6bn over four years from July 1 in an attempt to spread the benefits of the mining boom as well as to help cut the company tax rate, fund superannuation and provide infrastructure spending in the regions. It was also an integral part of the government’s plans to return the budget to surplus in 2012-13.
First question: Is the mining boom over? No, according to the government. Second question: If we’re still in a mining boom then why is its mining boom tax collecting no revenue? Answer: because it’s a failed tax, negotiated at the point of a gun and to regain power at any cost.
And of course, given the MRRT simply doesn’t work, neither do any of the benefits that were supposed to flow from it. Back to the AFR:
The Business Council of Australia has blamed ground rules set by Treasurer Wayne Swan for the failure of a business group set up to negotiate the government’s promised corporate tax cut.
The Business Tax Working Group said in a report last night it could not reach agreement on a way to cut the 30 per cent corporate rate.
…Even though they disagreed over the timing and some of the details, they agreed on the conclusion: a company tax cut was desirable but there was no consensus in the business community on how to pay for it.
I’d welcome a corporate tax cut. As the mining boom recedes, we’re going to need new investment to offset the decline in the mining capex growth model and the consumer borrow and spend growth model.
But the narrative in which it has to be delivered is not one of abundant wealth. Rather, it must be a context that acknowledges we aren’t different to everywhere else, just a little more lucky. We must:
- confess that households need to deleverage and will require public deficits to hold up demand as they undertake the task;
- install policies that remove the banks from public support so that we can run public deficits without risking credit downgrades to the entire financial system;
- use macro-prudential policies to prevent interest rate cuts from stimulating established house prices and slash rates to bring down the dollar and accelerate deleveraging,
- yoke wage gains directly to productivity growth.
The alternative is to rely on the fading “China put”. And whether by the sword of a current account crisis or the slow decay of time, we will watch our wealth decline.