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Treasury’s non-modelling of the stimulus
Late last year I published an article with Agenda (the public policy journal of ANU) that critiqued the Treasury “modelling” (sic) of the Rudd government stimulus that followed the global financial crisis. It is an article that I started writing a long time ago, but sat in the “to do” pile for too long.
My main point was that the Treasury approach was hopelessly inadequate, a point that is abundantly clear to any economist who glances at their attempt, and has been readily admitted by some Treasury friends. As I wrote in the article:
“The biggest problem with the Treasury model is that because it misunderstands the issue of international crowding out, it drastically underestimates the impact on net exports. In addition, it entirely ignores the issues of domestic crowding out, monetary policy responses, and the costs of repaying the debt. While its estimate for the private savings response to the stimulus is at the low end of the range, this is the least of the problems.
“The ignorance of open-economy macroeconomics suggests that Treasury has neglected much of the advances made in macroeconomics over recent decades, and its strange assumptions on domestic crowding out and private savings response show that it has forgotten much of its own research. As Harvard economics professor Robert Barro said in 2009 when the US was debating its own stimulus policies, ‘The financial crisis and possible depression do not invalidate everything we have learned about macroeconomics since 1936’ (Barro 2009).”
“Once in a generation budget”
Before the budget came down, Campbell Newman described it as a “once in a generation budget”. That is certainly what Queensland needed. Our long-term budget position is actually worse than the audit report or old budget papers claim, since they don’t factor in the growing fiscal pressures over the coming decades caused by an aging population. Put simply, current policies are unsustainable, and some tough decisions are needed.
The first thing to note is that the government decided to give up on fixing the 2012/13 budget.
They have allowed the operating deficit to increase from an estimated $4.9 billion (Audit) to $6.3 billion, and the fiscal deficit to increase from an estimated $9.5 billion (Audit) to $10.8 billion. This is perhaps understandable since the federal government has been playing games with their grants (shifting money around to try and manufacture a federal government surplus) and the lag time involved in reforms. So the real place to watch is the estimate for the 2013/14 budget balance.
The cost of bracket creep
Each year the government increases income tax rates, and most people don’t notice. They do this through “bracket creep” where workers are moved into higher tax brackets due to inflation. For example, if your income jumps from $37k to $38k to compensate you for higher prices, then you will be pushed up a tax bracket so that you are now paying a 35.5% marginal rate (instead of 20.5%) leaving you with less disposable real income.
This implicit tax increase could be easily removed by indexing the tax brackets to inflation.
To work out a rough estimate of the size of bracket creep, we can make the simplifying assumption that income tax should grow at the same rate as nominal GDP growth. Looking at the coming three years, nominal GDP is expected to increase by 16.9%, while income tax is expected to grow by 25% over the same three years. The difference can be attributed to bracket creep, and amounts to a total secret tax increase of $13 billion over three years.
If the government does not offer at least $13 billion worth of income tax “cuts” over the next three years, then they will actually be increasing income taxes.
Historically, the government has been happy to allow bracket creep to continue as it gives them extra tax revenue each year which they can then give away to special interest groups or loud lobby groups in the hope of buying an election victory. Because the tax increase is not well publicized and not well understood, the government is able to increase the tax burden with a relatively low political cost. But while it might make for good politics, the continuous increase in income taxes has been squeezing family budgets, reducing work incentives, and slowing down our economy.
In the long run we need to have income tax indexation. In the meantime, we need to demand at least a $13 billion income tax cut.
Note: If the government introduced an inflation indexation on income tax rates, that would ensure that nobody was pushed into a higher marginal tax bracket due to inflation. However, there would still be a gradual increase in average tax rates as real economic growth pushed more people into higher tax brackets. To ensure that there is no increase in average income tax rates it would be necessary to index tax brackets to nominal wage growth. But that is a topic for another day.
Australia’s income tax rates
Each year the government releases a budget that outlines our income tax system (among other things), and each year they hide the truth. Instead of simply reporting the marginal tax rates, the government reports three different sets of numbers (basic rates, medicare levy, LITO) and then leaves the reader none-the-wiser about how they interact to produce the actual income tax rates. The first time I publicly complained about this silliness was back in 2009.
In 2011 the government announced a series of changes to the income tax system as compensation for the impending carbon tax. At the time, I ran the numbers to show how they would change the actual tax rates.
Now that the 2012/13 Budget is out, it’s time to run the numbers again to strip away the magic and report the honest marginal tax rates faced by Australian workers. These numbers are quite similar to the numbers I reported last year, except for an increase in the threshold for the Medicare Levy. Last year I had pointed out that the Medicare Levy was going to kick in at a lower income than ordinary income tax starting in 2012-13… and it’s good to see that somebody in Treasury has noticed this problem and fixed it.
My 2012-13 Queensland budget
The recent Queensland budget audit showed an expected 2012-13 operating deficit of $4.9 billion (up from $4.2 billion), and proposed a range of tax increases and soft spending restraint over several years, with serious structural reform only briefly hinted at in a few sentences on page 203. We can do better.
This document shows how we can immediately return to surplus, fundamentally reform hospitals & schools, cut taxes in half, and slash regulation to get the economy booming.
The below reforms are a clear break from “business as usual” and would require brave political leadership. The spending cuts will be unpopular, especially from those people who previously received the “free” money.
However, while these reforms introduce some short-term pain, the long-term benefits are clear and significant. A more competitive hospital and school system will lead to better quality health and education. Dramatically lower taxes and fewer regulations will spur new investments and productivity growth – leading to more jobs and higher wages. And importantly, these reforms ensure the budget position is sustainable so that we do not leave a legacy of debt and deficits for future generations.
Government destroys 100,000 jobs while unions cheer
The recent announcement that the legislated minimum wage will increase by 2.9% means that we can expect there to be nearly 100,000 fewer jobs in Australia. In response, commentators and unions have cheered and asked for more.
This is a great example of Bastiat’s old rule about what is seen and what is not seen. When a business downsizes and people lose their jobs, the impact is immediate and visible – resulting in news headlines and stern-sounding politicians. But when the government subtly destroys thousands of jobs slowly and indirectly, they are given a free pass.
Of course, that is cold comfort for the unemployed.
Political lies & bank regulation
We hope that Joe Hockey is a liar. We can understand why a politician would want to bash banks, and we can understand why a politician would want to promise more regulation to control the “naughty market”. Both of these are populist positions which hit the political funny bone, and score cheap points.
It is no surprise that Wayne Swan regularly complains about evil bank profits, and we’re sure the Greens (and other assorted reds) would eagerly agree to more regulation. But while we can understand the political desire for populism, when it actually comes to managing the rules for our economy, we can only hope that Hockey is not serious about his stated desire to have the RBA act as referee on interest rates.
We already know that Joe Hockey wanted to introduce a psuedo-national bank, and he wanted more regulation to ensure that banks gave more risky loans, and also gave fewer risky loans.
Now the issue is whether banks should be able to set their own prices for loans. To be fair, Hockey has only suggested that the Reserve Bank of Australia (RBA) should nudge banks, but given his track record on not understanding finance it’s a dangerous start. It hints very much towards government regulation of interest rates, which is price fixing of some of the most important prices in the economy.
Walking down the road to serfdom
Over 60 years ago Hayek wrote “The Road to Serfdom“, which attempted to glimpse into the future of the western world. He predicted that if a country gave over significant control of it’s economy to central planners, then eventually the country would start to drift away from democracy. In the decades that followed, the UK and the rest of the west steadily gave more economic power to government but remained democratic, and so some concluded that Hayek’s predictions of doom were wrong.
Perhaps they were just premature.
Hayek argued that democracy can be slow and messy, but that economic decisions often need to be made quickly and decisively. If the government controls the economy, then the people have a choice between slow and messy economic decisions, or making the government less democratic so that leaders could “get things done”. As we look at the economic problems in Europe and America today, the lessons of Hayek seem very appropriate.
From American towns to the European countries of Greece and Italy, elected leaders are being replaced by technocrats. With growing debt problems, the idea that some Europeans may start to look for a “strong leader” to make “tough decisions” without having to deal with those “meddling and bumbling politicians” doesn’t sound too outlandish. Even in Australia, we have seen one commentator hint at the idea of suspending democracy so that leaders can take strong action.
The unforgivable stupidity of the anti-banking “libertarians”
At the recent Mises Seminar in Sydney there was a speech by Chris Leithner that explicitly called for the banning of fractional reserve (FR) banking. Leithner and other Australian libertarians (including Michael Conaghan & Benjamin Marks from Liberty Australia) follow the lead of some American libertarians (Walter Block, HH Hoppe, JG Hulsmann — BHH) and argue that FR-banking is fraud and should be banned, and further that it is economically damaging and causes inflation.
These two issues need to be addressed separately. The first is a deontological issue about whether FR-banking is consistent with a free world. The second is a consequentialist issue about whether FR-banking leads to bad outcomes. It is possible that FR-banking is consistent with freedom and yet leads to bad outcomes, and then those libertarians who accept the “non-aggression principle” would have to tolerate FR-banking even if they don’t like those outcomes. But before delving into that debate, it is worthwhile quickly explaining what we are actually talking about with FR-banking.
Vaults, loans & banks
Anything can be money. In jail (and POW camps) cigarettes have been used as money. In the early years of Australian settlement, rum was used as money. In some small island nations, shells have been used as money. Through much of history, precious metals (especially gold and silver) have been used as money. And today, the most common sort of money is “fiat” paper money that is created by government but is intrinsically worthless (ie it has no value except as money). This is not the place to go into a debate about what should be money or who should decide, but the important point is simply that there is some original supply of money that then becomes the standard “unit of account” and “store of value” and “medium of exchange” in an economy. For the sake of this discussion, this original supply will be called “base money” and in Australia it is created by the Reserve Bank of Australia (RBA).
Farmers, miners & private property rights
The debate about mining on agricultural land has long frustrated me. While one side argues to help the “farmers” and the other side wants to help the “miners” it seems everybody has abandoned the most obvious solution — clear allocation of private property rights. As nobel prize winner Ronald Coase explained, conflicts over resources can be solved by allocating private property rights and then allowing trade so that the resources end up going where they are most valuable.
So my suggested approach to the mining/farming debate has been to strengthen the private property rights of farmers so that they have the “right to say no” regarding access to their land. Miners can then deal directly with farm-owners to come to mutually beneficial deals regarding access. Unfortunately, this approach has been ignored by both sides of politics. Until now.
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